What is a common risk associated with private equity investments?

What is a common risk associated with private equity investments?

• A. Interest rate risk
• B. Illiquidity risk
• C. Currency risk
• D. Regulatory risk

Answer: (B)

Illiquidity risk is a well-known challenge in private equity investments due to the nature of these investments requiring capital to be tied up for extended periods, often several years. Unlike publicly traded assets, where investors can buy or sell shares on a stock exchange at any time, private equity investments typically require investors to commit capital to a fund for a duration defined by the fund's life cycle, which can range from 7 to 10 years or even longer. This extended investment horizon means that investors have limited or no access to their capital until the fund liquidates its holdings or completes exits, such as the sale of portfolio companies. Consequently, if investors need cash before the fund is fully liquidated, they may face challenges or be unable to recover their investment in a timely manner. This characteristic makes illiquidity risk particularly pronounced in the private equity space compared to other asset classes, where liquidity is more readily available. While interest rate risk, currency risk, and regulatory risk may also apply to private equity investments, illiquidity risk stands out as a predominant concern that directly impacts investor flexibility and access to capital.

Illiquidity risk is a well-known challenge in private equity investments due to the nature of these investments requiring capital to be tied up for extended periods, often several years. Unlike publicly traded assets, where investors can buy or sell shares on a stock exchange at any time, private equity investments typically require investors to commit capital to a fund for a duration defined by the fund's life cycle, which can range from 7 to 10 years or even longer.

This extended investment horizon means that investors have limited or no access to their capital until the fund liquidates its holdings or completes exits, such as the sale of portfolio companies. Consequently, if investors need cash before the fund is fully liquidated, they may face challenges or be unable to recover their investment in a timely manner. This characteristic makes illiquidity risk particularly pronounced in the private equity space compared to other asset classes, where liquidity is more readily available.

While interest rate risk, currency risk, and regulatory risk may also apply to private equity investments, illiquidity risk stands out as a predominant concern that directly impacts investor flexibility and access to capital.