Valuations in private markets have been called a “key risk” due to their infrequency. Our expert panel considers the drivers for faster valuations and the complexity of execution.
Participants
- Brian Slattery, head of Northern Europe, Clearwater Analytics
- Michaela Campbell, managing director, Hayfin Capital
- Louise Jack, COO, Local Pension Partnership Investments
- Victor Mayer, managing director, Pantheon
- Emily Pollock, co-founder & client director, Schroders Capital
Private markets are coming under pressure to produce valuations more frequently from, among others, the UK’s Financial Conduct Authority, which said in March that it would consult on the matter. Prior to this, the International Organization of Securities Commissions – in its ‘Thematic Analysis: Emerging Risks in Private Finance’ report – highlighted valuations as a key risk area in the sector.
Higher interest rates in the past two years could have exposed leveraged investments to volatility and lower valuations. But these price movements do not become apparent until a fund’s next valuation – and this could be weeks away. Two key drivers for regulatory scrutiny, therefore, are transparency and market stability.
At our expert panel, Victor Mayer, of Pantheon, highlighted the inherent delay in private markets valuations. “The lag for private markets valuations means investors see their private assets portfolios as they were six months ago, and certainly not how they compare on the day with public markets portfolios,” he said.
This lag creates a discrepancy in real time portfolio assessments, potentially misinforming investors about the actual state of their investments.
“It’s a back-office process that needs to be checked by a third party”
Brian Slattery, Clearwater Analytics
One of the significant hurdles in moving to more frequent valuations is the complexity and operational burden involved. Brian Slattery, of Clearwater Analytics, emphasised the challenges, saying: “It’s a back-office process that needs to be checked by a third party. But then you have to adjust for what is called post-preference date movement. This is where private valuations are adjusted for public market movements.”
Difficult to explain
This adjustment process, combined with the need to account for capital calls and distributions, can quickly become convoluted and difficult to explain to clients. Also, the often manual nature of the process makes faster valuations prone to error.
Slattery added that there was an administrative burden on asset managers to create teams capable of producing frequent valuations. “It’s a very difficult thing to do and complexity and resources are required to achieve this shift.”
Emily Pollock of Schroders Capital said the firm had hired a specialist team partly to support a more frequent valuation cycle, essentially building a whole other function within the organisation. This expansion signifies a substantial investment in resources and infrastructure to meet the demands of more frequent and accurate valuations, she said.
Schroders has entered the ‘semi-liquid’ market. These structures further push firms to produce more frequent valuations.
“Some of the semi-liquid structures, like the Long-term Asset Fund (LTAF) – which are targeted at DC pension funds, for example – are tightly regulated and there is a need for monthly NAVs in order to support investors who can more easily enter or leave these funds,” said Pollock.
Market noise
Louise Jack, COO of Local Pension Partnership Investments (LPPI), said that the appropriateness of valuation frequency depends significantly on the fund’s structure. For closed-ended funds, where trading is infrequent, quarterly or six-monthly valuations may suffice. However, for open-ended funds, more frequent valuations are necessary due to regular trading activities.
She added that, in her view, how a portfolio valuation is carried out is more important than the frequency.
“Quarterly reporting means investors are receiving fundamental valuations based on actual performance. But more frequent valuations, especially where a public market proxy may be used, can introduce ‘noise’.
“I have defended IRR for 15 years – but now I’m more inclined to question it”
Victor Mayer, Pantheon
“If you think back to Covid, although there was a dip in valuations, compared to public markets there was not nearly as much volatility. Valuations in public markets tended to bake in all kinds of expectations about the future that did not always play out, whereas private markets all ended up in the same place after a year or so – which was absolutely a strength of the asset class.”
Moreover, the use of complex spreadsheets in private market valuations introduces significant operational risks. She cautioned that “greater frequency means greater risk of error and larger operational overheads, so for there to be more frequent valuations, there have to be good reasons”.
Commenting on the issue of valuation frequency in private credit, Michaela Campbell at Hayfin Capital, says: “How evaluations are carried out is more important to their frequency. As the secondaries market for private credit continues to develop, this will provide a supportive environment for potentially requiring more frequent valuations,” emphasising that methodology is crucial to maintaining valuation integrity.
Doubts about IRR
The ‘internal rate of return’ – or “IRR” – is the most commonly used, private equity-made valuation methodology. Yet Victor Mayer of Pantheon called the IRR into question.
“I have defended it for 15 years – but now I’m more inclined to question it. I think IRR can be misleading and a GP may not be equipped to produce monthly valuations using IRR and they could need to use third-party providers to come in on an intra-quarter basis.”
Brian Slattery at Clearwater said: “While I don’t think the IRR should be scrapped, there should be more education about the difference between time-weighted return versus the internal rate of return. It’s not rocket science. An 8% IRR is roughly equivalent to 5% time-weighted return because of how capital calls are made. It’s very simple math and people need to understand the mismatch between the liquidity of the master fund and the illiquidity of the assets.”
Greater transparency
The move towards more frequent valuations in private markets investment funds is fraught with challenges but also presents opportunities for greater transparency and accuracy. While the operational burdens and risks are significant, the push for better methodologies and increased education within the industry is essential. As regulators and industry players work together to refine these processes, the ultimate goal remains to provide investors with timely and accurate information, bridging the gap between private and public market valuations.
