With Greater Liquidity Comes Greater Private Asset Valuation Frequency

By: Ryan MacLean

The demand for more frequent private security valuations are coming from every direction these days:

  • Mutual fund families are carving out a growing portion of their portfolios for private investments. While many nominally public security-focused funds historically could allocate up to 10% to less liquid private assets, many new specialty vehicles—especially industry-focused, thematic funds such as technology or biotech—have taken that threshold to as high as 25%. Data is sparse, but we estimate the total invested by U.S. mutual funds in non-public equity to be well over $10 billion.
  • On the other end of the spectrum, traditional private equity and private debt sponsors, partly in a bid to tap retail investors through intermediary channels, are launching products such as separately managed accounts and interval funds with more generous investor liquidity terms than ever before. And in private lending, many LP agreements, especially in Europe, have begun to include trigger thresholds that require a complete fundamental asset valuation if certain borrower metrics are breached.

While valuations for less liquid securities were historically undertaken on an infrequent basis—initially during audit season, then went to quarterly a few years ago—“monthly valuation” is the new buzz phrase (though some vehicles require even more frequent valuations than that). The change is taxing internal valuation teams and redefining the relationship between fund sponsors and outside valuation providers.

Been There, DCFed That

There is no doubt that fund sponsors requiring more frequent valuations are leaning more heavily on outside partners. Fund sponsors that previously spent two weeks per quarter modeling illiquids for quarterly valuation might instead take one week per month modeling for the monthly NAV strike, a 50% increase.

A partner that is active in the market and works with a number of funds can help. On top of the extra raw staffing, in many cases, they already will have evaluated a particular security on behalf of other clients, thereby enabling them to move quickly.

A New Level of Service Expectations

The new accelerated valuation schedule is more reactive than before. With quarterly valuations, there was often an opportunity to “let the dust settle” on developments before factoring them into valuations. When new information bearing on an illiquid asset’s value—say, new same-store sales data from the company or a strategic transaction involving two competitors—came to light, we often had the luxury of waiting to see how the market reacted to the development. That’s not the case when a NAV strike is seemingly never more than a few days away.

That means we must have clear channels of communication with clients—including on weekends. It also means documentation is more important than ever. Because we are more frequently compelled to rely on preliminary or incomplete information, it’s imperative that we document it as such in client communications—auditors, LPs, regulators, and stakeholders need a precise paper trail that clearly shows that while the information was thin, the valuation represented a best effort at the time.

Reporting deliverables can be automated and slimmed-down, too, since no GP wants a valuation report that they can’t even get through before the next one is delivered.

Syncing Valuations to the Rhythms of Private Markets

Finally, one additional aspect of greater valuation frequency should be emphasized—it doesn’t change the fact that portfolio company fundamentals are an essential component of private debt or private equity valuation.

After the pandemic, price volatility returned to public securities markets, but private asset valuations were slower to react to all of the “noise” coming from public markets. As it turned out, the private market was right to take a more measured approach because public securities snapped back with the next news cycle in many cases.

The takeaway? Just because you can change the marks more frequently doesn’t necessarily mean you should change them more frequently.

Conclusion

There is a market logic to more liquid investment vehicles investing in less liquid securities. Mutual fund shareholders and retail investors accessing alternative investment funds stand to benefit from greater diversification and illiquidity premia. But there is no getting around the fact that with greater shareholder liquidity comes greater valuation frequency. Funds that can recalibrate old ways of doing things and lean on trusted partners to help will have the easiest time embracing the change.