Why a family with private fund commitments needs a reserve sized on capital calls in a stress, and how to test whether its bonds and cash would cover them.
Size a family office's liquidity reserve to cover two years of net outflows in a stress: spending, taxes and philanthropy, plus capital calls at a stressed rate, minus the distributions a bad market would still deliver. On an illustrative $400m family with $60m of unfunded private equity commitments, that is $67.06m, 16.8 per cent of wealth, against the $24m that "two years of spending" suggests.
Worked in full in The Family Office Professional by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The question is usually put as a rule of thumb: a year or two of spending in cash. That rule was written for families without private fund commitments. Once the family has unfunded commitments, the largest outflow in a bad year is not the household budget but the capital calls, and they arrive exactly when distributions stop and listed assets are cheapest to sell.
A family with $400m of wealth: $215.0m in listed portfolios, $80m in private equity funds and $105.0m in real estate and direct holdings. Every figure is illustrative and in $m.
| Item | $m |
|---|---|
| Family spending | 12.0 |
| Taxes | 4.0 |
| Philanthropy | 2.0 |
| Fixed outflows a year | 18.0 |
| Unfunded private equity commitments | 60.0 |
| Private equity NAV | 80.0 |
| Stressed call rate, share of unfunded a year | 35% |
| Distribution rate, base case and stressed, share of NAV | 12% / 2% |
Net outflow in year t = fixed outflows + call rate × unfunded at the start of t − distribution rate × NAV at the start of t
Unfunded falls by each year's calls; NAV rises by calls and falls by distributions.
Reserve = sum of net outflows over the stress horizon.
| Year | Fixed outflows | Capital calls | Distributions | Net outflow |
|---|---|---|---|---|
| 1 | 18.0 | 21.0 | 1.6 | 37.4 |
| 2 | 18.0 | 13.65 | 1.99 | 29.66 |
| 36.0 | 34.65 | 3.59 | 67.06 |
Calls in year 1 are 35 per cent of $60.0m, $21.0m; in year 2, 35 per cent of the $39.0m left, $13.65m. Distributions fall from the $9.6m a normal year would bring to $1.6m. The base case, with distributions at 12 per cent of NAV, needs $50.08m; the stress adds $16.98m, entirely because distributions dry up while the calls continue.
A reserve is only as good as the price at which it can be turned into cash in the same stress. Apply a haircut to each source.
| Source | Value | Stress haircut | Available | Cumulative |
|---|---|---|---|---|
| Cash and deposits | 15.0 | 0% | 15.0 | 15.0 |
| Government bonds | 30.0 | 5% | 28.5 | 43.5 |
| Investment-grade credit | 20.0 | 15% | 17.0 | 60.5 |
| Listed equities | 150.0 | 30% | 105.0 | 165.5 |
The family needs $67.06m available without selling equities into a falling market. Its cash, government bonds and credit total $65.0m at par but $60.5m after haircuts: 0.9 times the need, short by $6.56m. In the stress it would have to sell $6.56m of equities at their marked-down value, $9.37m of pre-stress value. The fix is small, a modest shift from equities into bonds, but it is only visible once the calls are in the calculation.
The reserve is 2.79 times the rule of thumb. Two years of spending is $24m. Two years of all fixed outflows is $36.0m. The private equity programme adds the rest, and it is the part that cannot be postponed: a missed capital call carries default penalties that no family wants to discover.
A committed credit facility can stand in for part of the reserve, but only on two conditions: it is committed rather than uncommitted, and its covenants do not tighten in the same stress, for instance through a loan-to-value test on the very portfolio that has just fallen. A line that can be withdrawn when asset values drop is not liquidity; it is a source that disappears at the moment it is needed. Count it at zero until those terms have been read; the same logic for a company's revolver is worked in does an undrawn revolver count as liquidity.
| Call rate | 1 year | 2 years | 3 years | 2 years, % of wealth |
|---|---|---|---|---|
| 25% | 31.4 | 58.78 | 83.16 | 14.7% |
| 35% | 37.4 | 67.06 | 91.71 | 16.8% |
| 45% | 43.4 | 74.14 | 97.95 | 18.5% |
The horizon matters more than the call rate. Each extra year adds roughly the fixed outflows plus a share of what is left to call, while a higher call rate partly front-loads calls that would have come anyway. Choose the horizon from the family's own history of how long distributions dried up, not from a convention.
The commitment pace that builds the $60.0m of unfunded is worked in how much a family office should commit each year to private equity, and the ceiling on commitments a reserve can support in the overcommitment ratio calculation.
Project two stressed years of spending, taxes, philanthropy and capital calls, net only the distributions a bad market would still pay, and hold that amount in assets that keep their value in the same stress. For this family it is about a sixth of wealth, not two years of spending. The office's own cost, the other fixed outflow a family must fund, is modelled in the free workbook for this case.
Spending alone is the wrong base once the family has private fund commitments. In the worked case two years of spending is $24m, but two stressed years of spending, taxes, philanthropy and capital calls, net of reduced distributions, need $67.06m. The reserve can be held partly in high-quality bonds rather than cash, after a haircut.
They become the largest outflow in a bad year. In the worked case $60.0m of unfunded commitments called at 35 per cent a year produces $21.0m of calls in year 1 and $13.65m in year 2, while distributions fall to $1.6m and $1.99m. Without the calls the reserve would be $36.0m.
Haircuts reflect what each asset would fetch in the same stress. The worked case uses illustrative haircuts of 0 per cent on cash, 5 on government bonds, 15 on investment-grade credit and 30 on listed equities, so $65.0m of bonds, credit and cash counts as $60.5m, 0.9 times the need.
This article is one calculation from The Family Office Professional. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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