The economic paradigm is changing abruptly. The causes are well known: rising post-covid inflation, tightening monetary policies and Russian aggression in Ukraine. And the effects of this change are being felt in private markets, the star investment sector of recent years when central banks were pursuing an accommodating monetary policy, inflation had disappeared and geopolitical tensions were under control.
For Ryan McNelley, managing director and EMEA portfolio valuation leader, Daniel Turi, director portfolio valuation, and Armand Kantar, director valuation at Kroll Advisory, the big change for the private markets industry is the growth in volatility, they said ahead of a roundtable discussion on 27 October at the Luxembourg Chamber of Commerce.
Theoretically, this increase in volatility is felt more in public markets--“where there is more room for emotion and short-termism”--than in private markets, “where investors have a long-term view and see through the cycle,” said Kantar. In private markets, “the investment cycle is much longer than in the public market,” added Turi, “which brings stability to performance and asset valuation.”
Measuring private asset performance
But this volatility impacts private markets at two points in time: when funds are raised and when they exit. Volatility can lengthen the duration of these phases, said the three asset valuation specialists. This leads to a tendency to extend the life of a fund and the development of a secondary private market. In short, the introduction of arbitrage in portfolios, which seemed to be more the preserve of the public markets.
When we have economic headwinds, as we do now, it slows down commercial activity. It makes capital more expensive and harder to get and exits more uncertain.
“Hence the importance of the topic of private asset valuation,” insisted Kantar, to answer the question ‘does it make sense to transfer or sell such assets?’ And it is also important in calculating return expectations, McNelley continued. “When we have economic headwinds, as we do now, it slows down business activity. It makes capital more expensive and harder to come by and exits more uncertain. Every additional 50 basis point spread makes financing more expensive and impacts future returns. All this puts pressure on valuation.”
“The first consequence of the current volatility is to draw investors’ attention to issues that have previously been under the radar, one of which is the valuation of illiquid assets. This year, most asset classes have performed poorly. Very few have actually retained their value. From this point of view, measuring the performance of private assets is crucial. For this reason, valuation methods are currently under scrutiny,” said Turi.
The subject is important for investors. Investors “demand accurate, timely and independent valuations,” observed Kantar. “Their concern is to ensure that the data provided by developers [general partners] reflect the fair value of their assets. Independence is a key word. This is the philosophy of our service offering, a neutral approach based on cross-checking the pieces.”
All these global institutional investors are willing to put their money in Luxembourg because they feel it is a safe place.
The subject is also important for the Luxembourg financial centre, according to McNelley, who sees a significant potential reputational risk. “Luxembourg, with its central position in the European investment fund industry, needs to get to grips with the issue. The country has built its success on its reputation as a safe place for international investors to domicile their assets. All these global institutional investors are willing to put their money here because they feel it is a safe place. Market volatility puts all this under pressure. Alternative investment fund managers, responsible for risk monitoring and valuation, are therefore in the front line of protecting Luxembourg’s reputation. That is why it is essential, and this is the main message we want to give to the industry here, that when it comes to risk and valuation, in particular, you have to adopt best practice to make sure that we don't have problems. That would damage the reputation of Luxembourg.”
The data issue
Evaluation means data quality. The question of data will probably be a recurring theme in the coming years, say the three Kroll executives.
“As far as data on public contracts is concerned, there are many sources, which is not the case for private contracts. But now that private markets are growing and becoming more and more important to the real economy, regulators and governments will want to have more and more information and visibility on what is really going on. But they will face a major problem: data privacy. In our business as a valuator, we collect a lot of data, which gives us an in-depth knowledge of what is really going on in private markets. But we can’t disclose it because it’s confidential,” they stated.
For Turi, McNelley and Kantar, the issue of confidentiality will have to be debated and even regulated.
Read the original French version of this interview on the site. This article was published for the Paperjam+Delano Finance newsletter, the weekly source for financial news in Luxembourg. .