explaining the illiquidity premium

The illiquidity premium is the additional rewarded risk associated with holding an illiquid investment.

One of the attractions of private markets relative to public markets is the trade-off between enhanced returns and reduced liquidity, known as the “illiquidity premium”. Private market deals often require investors’ money to be “locked up” (i.e. non-realisable and cannot be withdrawn) for anything up to ten years. By way of compensation, investors’ should enjoy potentially much higher rates of return.

In the chart, we contrast the long-term expected returns, and range of returns, for US private equity vs a proxy for public equity and US private debt vs a proxy for US corporate bonds.  Whilst the potential for returns is clearly higher, the range of potential outcomes is much higher too, reflecting the higher risk-reward trade off.

Contrasting public market and private market expected & variability of returns reflects their different characteristics, risks and opportunities.

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