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The article in brief:
- Private credit industry fund managers have created new types of investment vehicles with different investor liquidity profiles and reporting deliverables, as such the teams charged with valuing the assets must scale their operations.
- With more investments in the portfolio, private credit managers are coming up with reporting approaches for both auditors and limited partners that are more meaningful and accessible.
- Even as they scrutinize how to optimize their internal teams, private credit manager valuation leaders also are leveraging technology tools and third-party service providers—both domestic and offshore—to meet the demands of scale.
Over the past several years, growth in private credit markets has left many market participants with a high-class problem: How to scale up their valuation operations and valuation reporting capabilities in a way that keeps auditors, LPs, and regulators happy while also keeping a lid on costs. With the greater number—and greater diversity—of everything from LPs, to fund vehicles, to portfolio investments, valuation leaders at private credit fund managers are asking critical questions: What is the appropriate level of detail in valuation reporting? The right frequency? And what is the optimal mix of resources—internal, external, and technological—to help meet the challenges of greater scale?
The following are some of the approaches to meeting the challenge of scale that we are seeing in the market.
Reporting and Valuation Frequency
Fund managers are becoming more flexible—and generally more parsimonious—in their reporting, with the amount of reporting detail typically driven by stakeholder demands. Auditors are generally satisfied with two-page summaries per position since they are going to look at work papers and models anyway. At the same time, LPs, on the other hand, are less interested in memos or long narratives because they might have hundreds of private investments across different managers. They want analytics—spreadsheet data they can put into their systems to create (aggregated) dashboard reporting for their stakeholders.
The frequency of valuation is driven more by the products, with interval funds, mutual fund structures, and non-traded BDCs requiring monthly, weekly, or sometimes even daily reporting. This creates challenges when financial reporting from portfolio companies is less frequent, but some funds have negotiated more frequent reporting as part of their loan agreements.
Some fund managers are also dealing with greater reporting frequency and portfolio volumes by “risk adjusting” where they take deeper valuation dives—giving greater focus to junior securities and stressed or distressed positions.
The frequency of valuation is driven more by the products, with interval funds, mutual fund structures, and non-traded BDCs requiring monthly, weekly, or sometimes even daily reporting.
Optimizing Third-Party Valuation Resources
Third-party valuation firms continue to provide an essential source of operational leverage for maxed out internal valuation teams, especially for managers offering products with frequent NAV requirements or generous investor liquidity terms. But there is interesting variability in how outside valuation providers are being used, with some funds seeking outside opinions on holdings with greater risk. In contrast, others hand off the more vanilla valuation work to third parties and handle the riskiest positions with their internal team. The less-is-sometimes-more trend in reporting extends to third-party valuation; many valuation firms are starting to deliver a one or two-page summary on more straight forward names (newer issuance debt or equity positions, or performing, near cost positions), and a more detailed report on stressed positions.
Optimizing Internal Resources
Credit fund managers faced with the challenges of scaling are also giving thought to their internal resources—both human and technological—and finding creative ways to do more with less.
For sizing internal teams against the portfolio, the main KPI is investments-per-team-member. We find that there are two broad approaches: For funds where the team is exclusively focused on valuation, the sweet spot is usually somewhere between 25 to 40 names per person, whereas for organizations where professionals are wearing more than just a valuation hat—e.g., conducting portfolio monitoring—the ideal workload is smaller, maybe a dozen positions. Funds are also finding success offshoring some of the internal valuation work to teams in India, though there are challenges implementing this long-distance model and sometimes with quality.
Third-party valuation firms continue to provide an essential source of operational leverage for maxed out internal valuation teams, especially for managers offering products with frequent NAV requirements or generous investor liquidity terms.
Technology Tools—and Their Limits
Another area where managers are finding efficiencies is leveraging technology tools for reporting. Funds are reporting success using reporting software, but many funds we talk to warn against trying to do too much. They say the tools are great for organizing portfolio data and reporting. Still, many that attempted to move their actual valuation models onto the platforms have gone back to using spreadsheets that they then link to the reporting software. Many have found that the software does not provide enough flexibility across changing valuation situations or security types to be useful.
A few lessons from firms that have successfully implemented off the shelf reporting software:
- Identify and support at least one power user; one fund has a dedicated data governance officer.
- Leverage the tools’ ability to monitor whether team members are keeping on top of input work.
- Be mindful of scalability; Will what you are building for 30 names work for 200?
- Be wary of consulting firms offering to set up integrated reporting software; the general consensus was that unless your securities are the plainest of plain-vanilla, you may spend more time fixing their mistakes than you saved by hiring them.
- Stick to using the software for portfolio monitoring slides, statistical analyses, and reporting.
With the tremendous influx of capital into private credit and the advent of new investment vehicles, valuation leaders are proving to be unafraid of questioning their previous processes and models to create new solutions not only to improve scale and efficiency within their firms, but also to provide improved, more efficient, and more cost-effective solutions for their clients. In essence, as clients’ valuation needs change, the stronger valuation firms quickly and creatively adapt to these changes and provide creative solutions.