According to Preqin’s Global Alternatives Report 2022, despite rising interest rates and inflation, prices of assets in the $13trn private markets have remained relatively high. This raises questions amongst regulators about how their valuations are conducted and if a correction is due.
On October 4, 2023, the UK’s financial regulator, the Financial Conduct Authority (“FCA”) said at its annual public meeting that it would be launching a review into private markets, as part of its joint evaluation with international regulators of the risks the non-bank sector could bring to financial stability. The FCA is not alone; globally there is an emergence of disclosure requirements for private funds. For example, US regulators at the Securities and Exchange Commission, through Final Rule IA-6383 released on August 23, 2023, have also recently responded to concerns about private markets by requiring funds to make more extensive disclosures about performance and expenses.
These moves by regulators are encouraging many managers to seek the benefits of an independent valuation of their assets by a qualified third party.
Valuation complexities in private markets
Valuations of private and unlisted assets are not exposed to the daily volatility that one sees in the public markets. In the public markets, securities are quoted and traded throughout the day and prices are readily available. In private markets, the underlying securities do not have daily volatility since the securities are typically “marked to market” on a quarterly basis. Therefore, there is an inherent lagging effect in reporting the impact of market conditions on valuations. For regulators, this could be addressed through more frequent valuations (i.e., monthly vs quarterly or annually).
One of the key challenges of valuing private assets is the inconsistency in available information. A private market investor may be a minority investor and not have information rights on the asset that they own, and by contrast a public market investor will have this information through regulatory filings even if the investor is a minority investor.
When valuing a private equity security, one typically relies on a discounted cash flow model. This model requires a financial forecast of the company and an understanding and discussion with management on the company's outlook and risks. Without information rights, a private investor would not be able to use this model in a credible way and would need to rely on another method.
This could be a backsolve method, which relies on the most recent round of financing to impute a value of the overall company. However, the facts and circumstances of the company may have dramatically changed since the most recent round of financing may have occurred, or the buyer of the most recent round may have a different investment thesis.
The other method would be using market multiples of guideline public companies. However, publicly traded companies may not be a direct comparison due to size, geographical reach, and the quality of management for example.
Demand for independent valuations rises
It is due to these complexities and challenges in private asset valuation in the current market environment, that private funds are increasingly turning to appropriately credentialed independent third parties to remove any biases in the valuations of their investments.
The changing macroeconomic environment and renewed focus of regulators on the private markets are prompting funds of all sizes to consider outsourcing valuations. We can draw parallels to the world of environmental, social, and governance in private markets where, this year, we have seen that even the largest private markets participants are no longer “marking their own homework” – or in this case valuation models - with greater integrity and oversight provided by an independent verification process.
How can we help?
Our Valuation Services provide periodic valuations – including for illiquid financial instruments such as equity, debt, and derivatives to meet their specific reporting requirements, throughout all stages of a fund’s lifecycle. We understand the complexity of valuing illiquid financial instruments and our team consists of leading industry experts who have a proven track record of helping clients with their reporting requirements.
Apex Group offers these services to a wide range of investor types, including private equity and debt funds, hedge funds, venture capital, mutual funds, structured credit, family offices, pension funds as well as corporates, insurance companies, banking, and other financial institutions.
Contact us to find out more about how we can provide an independent valuation of your portfolio.
