Explain how the liquidity of asset classes affects asset allocation decisions

Private equity, private credit, real estate and infrastructure are hard to model and hard to trade. Their return series are appraisal-based, so reported volatility and correlations are understated, and there are few investable indices; performance depends heavily on manager selection. Options include excluding such classes from optimisation and setting their weights separately, using public-market proxies such as listed real estate or small-cap equities with adjusted inputs, or unsmoothing returns and adding explicit liquidity constraints. Investor size and horizon matter: a large endowment with modest spending can harvest illiquidity premiums, while a small investor may lack access and diversification across managers and vintages. The trap is letting an optimiser overallocate to private assets because their smoothed data make them look safe.