As allocations to – and the democratisation of – private market assets expand apace, regulators are increasingly thinking about the risks these investments may pose, taking a closer look at valuation methods in particular. Companies backed by venture capital may present more challenges in that regard as they are newer and have minimal or no track records.
On Wednesday, the Australian Securities and Investments Commission (ASIC) and the UK’s Financial Conduct Authority (FCA) published a discussion paper and portfolio letter, respectively, flagging their concerns and how they are looking at addressing them. (See Private Equity International‘s Side Letter on Wednesday for more on ASIC’s document.)
A key focus for both watchdogs is ensuring private assets are valued appropriately and accurately, given they lack the frequent trading and price discovery of liquid public markets.
ASIC wants to better understand the risks associated with private markets, especially in light of expanded retail participation. It highlights concerns among market practitioners about the quality of private asset valuations and their responsiveness to changes in market conditions – and about the increased use of secondaries options and continuation funds.
Similarly, the FCA’s priorities include ensuring that investment firms have robust valuation procedures for private assets and manage conflicts of interest effectively around, for instance, continuation vehicles, co-investment opportunities and partnering with other financial institutions. It will launch a multi-firm review on conflicts this year.
“It’s encouraging to see the FCA shining a spotlight on private market valuations as building sensible frameworks in this area should enhance confidence amongst investors within the illiquids space altogether,” said David Stears, head of valuations at UK accounting firm Buzzacott and former head of valuations at the UK’s Universities Superannuation Scheme.
“I also think they’ve hit the nail on the head by highlighting insufficient expertise and poorly managed conflicts of interest as key risks,” he told PEI. “Whilst subjectivity in private market valuations will always exist, undue bias – or mere error – may undermine faith in those marks, as well as lead to wider issues for both asset managers and their clients.”
Semi-liquid funds
A group particularly alert to the challenge of marking illiquid assets is managers of semi-liquid funds, a fast-growing segment of strategies offering open-end access to private markets. These GPs must price assets frequently enough to allow subscriptions and redemptions as often as monthly. (Listed PE funds represent a related, growing channel.)
Schroders Capital offers several semi-liquid products, including its newest Long-Term Asset Fund: the UK Innovation LTAF, a venture-focused strategy that last week first-closed on £500 million ($631.3 million; €605.2 million). LTAFs are UK open-end vehicles that enable investment in long-term, illiquid assets.
When it comes to pricing, Schroders has a longstanding PE and venture platform with a 10-strong in-house valuation team that is part of the 50-person fund operations division, said investment director Harry Raikes, who co-manages the new LTAF.
The team is used to doing monthly revaluations of these vehicles and is completely independent of the investment side of the business, he told PEI. It uses the International Private Equity Valuation guidelines.
For direct investments, Schroders uses the relevant information it receives from the companies in question, said Raikes. If it invests alongside other GPs, it will also receive their valuations of the holdings. “We can often have multiple viewpoints on the valuation of a given company by virtue of our access into other fund managers that also valued that same business.”
Citing UK fintech firm Revolut as an example, he said: “We’ve been in funds that have been in every single funding round of that business and we know how each of those different fund managers view the valuation at a given point in time. That is a relevant factor that our valuation team can consider when they’re pulling in a whole range of different inputs.”
Then the valuation team reports the valuations through Schroders’ different valuation committees: at the PE level, then Schroders Capital for private assets, then Schroders at the group level.
“They go through a high degree of scrutiny during that process” and undergo an audit at least once a year to obtain third-party validation, Raikes added.
The valuation team can also use external valuers if they don’t feel they have sufficient information or expertise, he said.
Venture valuation
Venture capital investment poses particular valuation challenges as it backs new businesses with little or no track record. Pricing such assets is easiest when there is visibility on financial metrics, enabling benchmarking to public valuations or comparable transactions, said Raikes.
“It can get more difficult if you go into an area like life sciences, where companies are developing drugs through a clinical pathway where you’ve got no visibility on financials,” he added. “You may have precedent transactions for companies that have previously sold at that stage and they’re more difficult to price.
“But our team has an exceptional amount of experience of valuing these holdings over long periods of times.”
For some firms, however, marking assets more frequently will mean a bigger change.
Investment consultancy WTW needed to develop a valuation process for its new private equity co-investment LTAF, which received regulatory approval in October last year. The process took at least a year to put in place because of its complexity, said Andrew Brown, WTW’s head of private equity.
The LTAF guidelines required “periodic” valuations, with the FCA requesting information on how WTW does them and how frequently, he told PEI. Ultimately, WTW brought in a third-party independent firm to do valuations once a month.
“Essentially, every month we had four independent sets of eyes looking at the valuation,” Brown said. “My expectation is the market will eventually move in that direction.”
As allocations to – and the democratisation of – private market assets expand apace, regulators are increasingly thinking about the risks these investments may pose, taking a closer look at valuation methods in particular. Companies backed by venture capital may present more challenges in that regard as they are newer and have minimal or no track records.
On Wednesday, the Australian Securities and Investments Commission (ASIC) and the UK’s Financial Conduct Authority (FCA) published a discussion paper and portfolio letter, respectively, flagging their concerns and how they are looking at addressing them. (See Private Equity International‘s Side Letter on Wednesday for more on ASIC’s document.)
A key focus for both watchdogs is ensuring private assets are valued appropriately and accurately, given they lack the frequent trading and price discovery of liquid public markets.
ASIC wants to better understand the risks associated with private markets, especially in light of expanded retail participation. It highlights concerns among market practitioners about the quality of private asset valuations and their responsiveness to changes in market conditions – and about the increased use of secondaries options and continuation funds.
Similarly, the FCA’s priorities include ensuring that investment firms have robust valuation procedures for private assets and manage conflicts of interest effectively around, for instance, continuation vehicles, co-investment opportunities and partnering with other financial institutions. It will launch a multi-firm review on conflicts this year.
“It’s encouraging to see the FCA shining a spotlight on private market valuations as building sensible frameworks in this area should enhance confidence amongst investors within the illiquids space altogether,” said David Stears, head of valuations at UK accounting firm Buzzacott and former head of valuations at the UK’s Universities Superannuation Scheme.
“I also think they’ve hit the nail on the head by highlighting insufficient expertise and poorly managed conflicts of interest as key risks,” he told PEI. “Whilst subjectivity in private market valuations will always exist, undue bias – or mere error – may undermine faith in those marks, as well as lead to wider issues for both asset managers and their clients.”
Semi-liquid funds
A group particularly alert to the challenge of marking illiquid assets is managers of semi-liquid funds, a fast-growing segment of strategies offering open-end access to private markets. These GPs must price assets frequently enough to allow subscriptions and redemptions as often as monthly. (Listed PE funds represent a related, growing channel.)
Schroders Capital offers several semi-liquid products, including its newest Long-Term Asset Fund: the UK Innovation LTAF, a venture-focused strategy that last week first-closed on £500 million ($631.3 million; €605.2 million). LTAFs are UK open-end vehicles that enable investment in long-term, illiquid assets.
When it comes to pricing, Schroders has a longstanding PE and venture platform with a 10-strong in-house valuation team that is part of the 50-person fund operations division, said investment director Harry Raikes, who co-manages the new LTAF.
The team is used to doing monthly revaluations of these vehicles and is completely independent of the investment side of the business, he told PEI. It uses the International Private Equity Valuation guidelines.
For direct investments, Schroders uses the relevant information it receives from the companies in question, said Raikes. If it invests alongside other GPs, it will also receive their valuations of the holdings. “We can often have multiple viewpoints on the valuation of a given company by virtue of our access into other fund managers that also valued that same business.”
Citing UK fintech firm Revolut as an example, he said: “We’ve been in funds that have been in every single funding round of that business and we know how each of those different fund managers view the valuation at a given point in time. That is a relevant factor that our valuation team can consider when they’re pulling in a whole range of different inputs.”
Then the valuation team reports the valuations through Schroders’ different valuation committees: at the PE level, then Schroders Capital for private assets, then Schroders at the group level.
“They go through a high degree of scrutiny during that process” and undergo an audit at least once a year to obtain third-party validation, Raikes added.
The valuation team can also use external valuers if they don’t feel they have sufficient information or expertise, he said.
Venture valuation
Venture capital investment poses particular valuation challenges as it backs new businesses with little or no track record. Pricing such assets is easiest when there is visibility on financial metrics, enabling benchmarking to public valuations or comparable transactions, said Raikes.
“It can get more difficult if you go into an area like life sciences, where companies are developing drugs through a clinical pathway where you’ve got no visibility on financials,” he added. “You may have precedent transactions for companies that have previously sold at that stage and they’re more difficult to price.
“But our team has an exceptional amount of experience of valuing these holdings over long periods of times.”
For some firms, however, marking assets more frequently will mean a bigger change.
Investment consultancy WTW needed to develop a valuation process for its new private equity co-investment LTAF, which received regulatory approval in October last year. The process took at least a year to put in place because of its complexity, said Andrew Brown, WTW’s head of private equity.
The LTAF guidelines required “periodic” valuations, with the FCA requesting information on how WTW does them and how frequently, he told PEI. Ultimately, WTW brought in a third-party independent firm to do valuations once a month.
“Essentially, every month we had four independent sets of eyes looking at the valuation,” Brown said. “My expectation is the market will eventually move in that direction.”
