Landmark Partners Analyzes Denominator Issues

Thanks to considerable drops in the stock market, private equity investors face the Denominator Effect, an issue Landmark Partners addresses in a new white paper. The Denominator Effect has caused overcommitted private equity investors to refrain from making new commitments or dramatically reduce their future investment page. The Landmark Partners white paper addresses why, in the firm’s view, this approach may be suboptimal.

The Denominator Effect arises when some fraction of a portfolio is allocated to each of several asset classes. If the total value of the portfolio – the denominator of the fraction – goes down, then the amount invested in each class – the numerator – needs to decline as well to satisfy the asset allocation policy.

At the end of 2008, many private equity funds have reported declines in Net Asset Value (NAV) of about 20%. Public stock indexes have dropped much further, and are down 35% or more since the beginning of 2008.

Many investors therefore believe that they are now overcommitted to private equity, and that they should refrain from making new commitments or dramatically reduce their future investment pace until their balances are back in line with their target allocation percentages.

In Landmark’s view, this approach may be suboptimal for many investors, for at least three reasons.

First, the firm believes that the stated decline in private equity NAV through the end of 2008 does not fully reflect economic reality. The Landmark white paper shows that private equity investors should expect an aggregate drop in value of 50% or more, meaning that many investors actually may be underinvested in private equity. Second, the firm believes that investors who do not make private equity commitments in the next year or two will be missing good buying opportunities. Third, a start-and-stop approach is very disruptive to the skill base and relationships that are critical to a successful private equity program.

Some changes in strategy and manager selection may be important for many investors in the new economic environment. Others who need liquidity may want to consider a secondary sale. Overall, though, Landmark would recommend that private equity investors who wish to remain exposed to this asset class should continue to make new commitments proportional to the size of their overall portfolios. The white paper includes worked-out examples of the consequences of trying to stop and restart a commitment process, and contrasts them with a steady program of new commitments proportional to the size of the overall investment portfolio.

For a copy of the white paper, email Ian Charles ( or Barry Griffiths (