Diversification, manager exposure across re-ups, share of the fund and the cost of monitoring each set a limit; the commitment is the one that binds.
Take the smallest of three ceilings, and check it clears a floor: the annual budget divided by the number of funds diversification needs, a cap on exposure to one manager across all its live funds, and a maximum share of the fund itself. For an illustrative 5,000 plan committing 150 a year, that gives 30 per fund, 0.6 per cent of the plan, with a floor of 20 below which monitoring costs more than 10 basis points a year.
Worked in full in The Private Markets Limited Partner by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Commitment size is usually set by habit: a round number that feels right for the plan. It should be the output of a short calculation, because the wrong size fails in a predictable way. Too large and one manager dominates the book once re-ups stack up; too small and the programme holds more relationships than the team can monitor.
| Input | Value |
|---|---|
| Total plan assets | 5,000 |
| Private equity target, 15%, as NAV | 750 |
| Annual commitment budget, from the pacing model | 150 |
| Minimum new funds a year for diversification | 5 |
| Overcommitment: (NAV + unfunded) ÷ target NAV | 1.6x |
| Policy cap on one manager, share of NAV + unfunded | 10% |
| Policy cap on share of any one fund | 10% |
| Re-up cycle with each manager | every 3 years |
| Monitoring cost per fund relationship, a year | 0.02 |
| Maximum monitoring cost, share of commitment | 0.10% |
The budget of 150 comes from the pacing model, as worked in how much to commit each year to private equity; the overcommitment ratio is the one tested in what overcommitment ratio a programme can afford.
Ceiling 1: diversification. Roughly 15 funds capture most of the diversification available, and with funds living ten years or more, three vintages of 5 a year give that many in the active phase at any time. Budget divided by funds: 150 ÷ 5 = 30.
Ceiling 2: the manager, not the fund. The 10 per cent cap applies to everything the plan has with one manager: 10% × (750 × 1.6) = 120 of NAV plus unfunded. The trap is that a manager re-upped every three years has three or four funds alive at once. Using an illustrative exposure profile per unit committed (NAV plus unfunded, by fund age), the overlap peaks when the newest fund is just signed:
Peak exposure per unit committed = e(0) + e(3) + e(6) + e(9) = 1.00 + 1.05 + 0.82 + 0.32 = 3.19
Maximum commitment per fund = 120 ÷ 3.19 = 37.6
In Excel, with the profile by age in B2:B13 and a three-year cycle: =MAX(B2+B5+B8+B11, B3+B6+B9+B12, B4+B7+B10+B13), then divide the manager cap by the result.
Ceiling 3: share of the fund. At most 10 per cent of any one fund, so 25 in a 250 fund, 60 in a 600 fund and 150 in a 1,500 fund.
The floor: cost. A relationship costs 0.02 a year in staff time, travel, legal review and operational monitoring. Keeping that below 0.10 per cent of the commitment needs at least 0.02 ÷ 0.001 = 20.
| Fund size | Diversification | Manager cap | Fund share | Commitment | Binding limit |
|---|---|---|---|---|---|
| 250 | 30.0 | 37.6 | 25 | 25.0 | Fund share |
| 600 | 30.0 | 37.6 | 60 | 30.0 | Diversification |
| 1,500 | 30.0 | 37.6 | 150 | 30.0 | Diversification |
The answer is 30 for most funds: 0.6 per cent of the plan, 4.0 per cent of the target NAV and 20 per cent of the annual budget. Only a small fund pulls it down, to 25. At 30, the exposure to a manager re-upped every three years peaks at 30 × 3.19 = 95.7, 8.0 per cent of programme exposure, comfortably inside the 10 per cent cap. Monitoring costs 0.067 per cent a year of the commitment.
The range is narrow: 20 to 30. A plan that pushes commitments below 20 to add managers needs 7.5 funds a year at the floor and pays for relationships it cannot follow; one that goes above 30 gives up diversification before it reaches the manager limit.
| Assumption changed | Peak exposure per unit | Manager cap | Maximum per fund |
|---|---|---|---|
| Re-up every 2 years | 4.55 | 120 | 26.4 |
| Re-up every 3 years | 3.19 | 120 | 37.6 |
| Re-up every 4 years | 2.51 | 120 | 47.8 |
| Re-up every 5 years | 2.13 | 120 | 56.3 |
| Overcommitment 1.3x, 3-year cycle | 3.19 | 98 | 30.6 |
| Overcommitment 1.9x, 3-year cycle | 3.19 | 142 | 44.7 |
A manager that raises every two years becomes the binding limit at 26.4, below the diversification ceiling. That is the case that catches LPs out: the size that was right for Fund III is too large once Fund IV and Fund V arrive on a faster cycle. A plan with less overcommitment has a smaller exposure base, and its manager ceiling drops to 30.6.
Applying the concentration limit to a single commitment. Ten per cent of 1,200 is 120, and a plan that commits 120 to one fund looks compliant on the day it signs. Three re-ups later its exposure to that manager is 120 × 3.19 = 382.8, 31.9 per cent of the programme. The limit has to be divided by the re-up overlap before it says anything about one commitment.
The fund-share cap works in both directions. Being 10 per cent of a small fund buys influence on the advisory committee and side letter terms; being 2 per cent of a large one buys almost none. Some LPs therefore set a floor on fund share as well as a ceiling.
Divide the budget by the funds you need, divide the manager cap by the re-up overlap, cap the share of the fund, and keep the result above the cost floor. Here that is 30 per fund, 0.6 per cent of the plan, with a manager re-upping every two years the first to force it lower. The programme figures behind these limits are in the free workbook for this book.
Many LPs cap it at around 10 per cent, so that the fund does not depend on them and they do not depend on one vehicle. In the illustrative case that cap binds only for small funds: 25 in a 250 fund, against 30 from the diversification ceiling for larger ones. In a 1,500 fund a 30 commitment is 2.0 per cent.
They multiply it. With a manager raising every three years, three or four of its funds are alive at once, and the illustrative exposure per unit committed peaks at 3.19. A 120 manager cap therefore allows 37.6 per fund, and only 26.4 if the manager raises every two years.
The one at which monitoring costs stay below a set share of the commitment. If a relationship costs 0.02 a year to follow properly and the plan accepts 0.10 per cent, the floor is 20. Below that a plan holds more relationships than it can follow: at the floor, a 150 budget needs 7.5 funds a year.
This article is one calculation from The Private Markets Limited Partner. 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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