Liquidity Stress Scenarios

Liquidity Stress Scenarios are structured tests of how the portfolio behaves under adverse conditions: market drawdowns, distribution droughts, higher capital call intensity, credit tightening, and unexpected spending needs. In private markets-heavy portfolios, liquidity failures rarely come from one event—they come from correlated stress: public markets down (denominator effect), distributions slow, and calls continue.

From an allocator perspective, liquidity stress testing is not conservative theater. It’s how you prevent forced actions that permanently damage returns and governance credibility.

How allocators define liquidity stress risk drivers

Allocators evaluate stress through:

• Distribution slowdown assumptions: base vs severe drought
• Capital call acceleration risk: heavier call periods in stress
• Public market drawdown impacts: denominator effect and drift
• Credit availability: reduced ability to borrow or use lines
• Spending/liability shocks: endowment spending needs, pension payments
• Asset sale constraints: what can actually be sold and at what discount
• Policy triggers: what forces rebalancing or de-risking actions

Allocator framing:
“Can we fund obligations without forced selling—or will liquidity pressure dictate investment decisions?”

Where stress scenarios matter most

• portfolios with high illiquid allocations
• endowments with fixed spending policies
• pensions with liability-driven needs
• environments with declining distributions and volatile publics

How stress testing changes outcomes

Strong stress discipline:

• prevents over-commitment and hidden liquidity traps
• supports steady pacing through cycles
• reduces panic-driven manager terminations
• increases governance confidence under pressure

Weak stress discipline:

• triggers forced selling and secondary discounts
• creates commitment freezes and missed vintages
• increases reputational and fiduciary risk
• causes inconsistent decision-making under stress

How allocators evaluate discipline

Conviction increases when:

• scenarios are explicit, repeatable, and reviewed regularly
• assumptions are conservative but realistic
• liquidity buffers are clearly defined
• actions are pre-committed (“if X happens, we do Y”)

What slows decision-making

• no clear stress framework or stale assumptions
• inability to model private cashflows under stress
• unclear liquidity buffers and triggers
• governance conflict about what actions to take

Common misconceptions

• “We can sell something if needed” → many assets aren’t sellable in stress.
• “Illiquids reduce volatility” → they often delay recognition and constrain action.
• “Stress testing is for big institutions” → any programmatic allocator needs it.

Key questions during diligence

• What stress scenarios do you run and how often?
• What assumptions do you use for distribution drought?
• What liquidity buffers exist and what triggers their use?
• What assets can be sold quickly and what discounts are assumed?
• How do scenarios influence pacing and rebalancing decisions?