Traditional asset valuation and allocation models are based on Modern Portfolio Theory (MPT), which takes into account certain characteristics of the portfolio and the investor: Expected return of each asset Volatility of each asset Pairwise correlations of each asset against every other asset Risk tolerance of the investor The characteristics that we have covered in previous sections combine to make traditional pricing models ineffective when it comes to private equity: Smoothed valuations. Unlike public equity investors, Limited Partners cannot access real-time data on the value of investments in a fund during its lifetime. They rely on periodic updates from the General Partner which are smoothed by nature and can lead to investors incorrectly valuing their portfolio and underestimating volatility.  Private vs public equity pricing. Private equity investments cannot be liquidated immediately for their fair value. Since this is how public assets are priced on an open market (i.e. fair market value), liquid asset prices and private equity asset value are not directly comparable. Cash flow uncertainty. While managers generally try to predict the distribution schedule of a fund in advance, the true schedule or magnitude of cash flows are unpredictable. This means that the present value of a fund as a function of its future cash flows is almost impossible to calculate. Rebalancing friction. The illiquid nature of private equity investments mean that rebalancing is rarely immediate - unless a secondary market is available. To compensate for the illiquidity, a liquidity premium must be taken into account when valuing the asset, which will be constantly changing as distributions are closer.