Denominator effect

A ratio moving because its denominator changed rather than its numerator. In private markets: when public holdings fall, lagged private valuations become a larger share of the total, pushing the allocation above target.

Where you will meet it

Denominator effect appears in 5 learning outcomes on the CFA syllabus. A few of them:

• Set out how valuation multiples change over the business cycle
  CFA Level II · Portfolio Construction

  “Beyond this denominator effect, multiples rise when real rates or risk premiums fall or long-term growth expectations improve, and fall when those move the other way.”

• Explain the tools available to manage liquidity risk in a portfolio
  CFA Level III · Portfolio Management Pathway

  “The trap is the denominator effect: when public markets fall, private assets become a larger share of the portfolio, breaching limits and squeezing liquidity when calls keep arriving.”

• Weigh the return potential and risks of private versus public market exposure within a long-term strategic allocation
  CFA Level III · Private Markets Pathway

  “A good recommendation also covers the denominator effect: when public markets fall, the private share rises above target, and rebalancing is slow and costly.”

• Explain why planning for liquidity is central when committing money to alternatives
  CFA Level III · Portfolio Construction

  “A trap is the denominator effect: when public assets fall, the private share rises above target.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with D · Glossary