Overcommitment is a liquidity calculation: the ceiling is set by the year in which capital calls continue and distributions stop.
The overcommitment ratio is (NAV + unfunded commitments) ÷ target allocation, and the maximum a programme can afford is the one at which two stressed years of net capital calls just exhaust the liquidity reserve. On a 300 programme with a reserve of 100, calls at 35 per cent of unfunded and distributions at 4 per cent of NAV, the ceiling is 1.72x, barely above the 1.70x already carried. A base-case check would have approved 2.40x.
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 →
Every private equity programme overcommits. Capital is called over years and starts coming back before it is all drawn, so committing only the target allocation leaves the investor permanently underweight. The question is how far beyond the target the commitments can go. The answer is not a market convention; it is a liquidity calculation, and the variable that sets it is the year in which calls continue and distributions stop.
| Input | Value |
|---|---|
| Total plan | 2,000 |
| Private equity NAV (15 per cent target) | 300 |
| Unfunded commitments | 210 |
| Liquidity reserve available for calls (5 per cent of plan) | 100 |
| Normal year: calls / distributions | 25% of unfunded / 20% of NAV |
| Stressed year: calls / distributions | 35% of unfunded / 4% of NAV |
| Private markdown at the start of the stress | −10% |
| Stress horizon | 2 years |
Overcommitment ratio = (NAV + unfunded) ÷ target NAV = (300 + 210) ÷ 300 = 1.70x
Total exposure is 510 against a target of 300. In Excel: =(B3+B4)/B3.
A ratio above 1.0x is the point of the exercise, not a risk in itself. Unfunded commitments are not a liability that falls due at once: they are drawn over several years, and a share of them is never called at all. The risk lies entirely in the timing, in how much of the unfunded is called in the same years that the portfolio stops returning cash. That is what the next step measures.
In a stress, managers call faster (they are buying cheaply and supporting portfolio companies) while exits stop. Project two years, with unfunded and NAV updated each year.
Net callsy = call rate × unfundedy−1 − distribution rate × NAVy−1
Year 1: 35% × 210 = 73.5 called; 4% × 270 (300 after a 10 per cent markdown) = 10.8 distributed; net 62.7.
Year 2: 35% × 136.5 = 47.8 called; 4% × 332.7 = 13.3 distributed; net 34.5.
Two-year net calls: 97.2 against a reserve of 100. Headroom: 2.8.
| Year | Calls | Distributions | Net calls | Cumulative | Unfunded at end |
|---|---|---|---|---|---|
| Normal, year 1 | 52.5 | 60.0 | −7.5 | −7.5 | 157.5 |
| Normal, year 2 | 39.4 | 58.5 | −19.1 | −26.6 | 118.1 |
| Stressed, year 1 | 73.5 | 10.8 | 62.7 | 62.7 | 136.5 |
| Stressed, year 2 | 47.8 | 13.3 | 34.5 | 97.2 | 88.7 |
In normal years the programme funds itself and returns 26.6 to the plan. In stressed years it consumes 97.2. The ratio is the same 1.70x in both; what changed is that the distributions which normally pay for the calls disappeared.
Raise the unfunded until the two-year stressed net calls equal the reserve. In Excel, Goal Seek the unfunded cell so that cumulative net calls equal 100.
Maximum unfunded = 215.0. Maximum ratio = (300 + 215.0) ÷ 300 = 1.72x.
Room for new commitments today: 5.0. The programme is, in effect, full.
| Stressed call rate | Max unfunded, distributions 4% | Ratio | Max unfunded, distributions 10% | Ratio |
|---|---|---|---|---|
| 25% | 283.4 | 1.94x | 366.8 | 2.22x |
| 35% | 215.0 | 1.72x | 278.9 | 1.93x |
| 45% | 178.3 | 1.59x | 231.9 | 1.77x |
The affordable ratio runs from 1.59x to 2.22x on the same programme and the same reserve. The distribution assumption is worth as much as the call assumption, and it is the one that tends to be set optimistically, because distributions in the base case are what make the programme look self-funding.
The reserve is the lever the investor controls. The call and distribution rates belong to the managers and the market. If a higher ratio is wanted, the honest route is a larger liquidity reserve, priced as what it costs to hold, not a kinder stress assumption.
The common mistake is to test the ratio against the base case. Double the unfunded to 420, a ratio of 2.40x, and the normal two years need net calls of 54.8, comfortably inside a reserve of 100. The programme passes. Run the stress on the same 420 and net calls are 215.5, a shortfall of 115.5, to be met by selling public assets at the bottom or private interests at a discount. A ratio approved on the base case is a bet that the stress never arrives, and the stress is the only scenario in which the ratio matters.
Set the overcommitment ratio from the bottom up: decide the reserve, project two stressed years of calls and distributions, and solve for the unfunded that the reserve can carry. Then compare it with what is already committed before signing the next fund. The stressed liquidity forecast and the buffer priced as insurance are in the free workbook and cases for this book. What a stress does to the allocation itself is in how to calculate the denominator effect; whether a fund can call more than the commitment, in can a fund call more than my commitment.
There is no safe convention; it follows from liquidity. On an illustrative 300 programme with a reserve of 100, the affordable ratio runs from 1.59x to 2.22x depending on stressed call rates of 25 to 45 per cent and distributions of 4 or 10 per cent of NAV.
Because in normal years distributions pay for calls. At 2.40x the illustrative programme needs only 54.8 of net calls over two normal years, but 215.5 in a two-year stress, a shortfall of 115.5 against a reserve of 100.
By enlarging the liquidity reserve, not by softening the stress. Call and distribution rates belong to managers and markets; the reserve is the only input the investor controls. Each addition to it should be priced at what holding it costs the portfolio.
Chapter 7 of The Private Markets Limited Partner sizes the liquidity buffer for a stressed year; the companion files price it as insurance. 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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