Allocation to alternative asset classes has been rising over the past 20 years, thanks to ageing populations, the search for higher yield and the increased sophistication of retail investors, explained Rafaël Le Saux, director at PWC Luxembourg and Chartered Alternative Investment Analyst association (Caia) Luxembourg chapter executive, during a conference dedicated to financial modelling for alternative investments. The event, held on 10 February 2025, was organised by the Luxembourg chapter of the Caia, together with PWC Luxembourg, the CFA Society, Financial Modelling Institute and Chartered Institute for Securities & Investment (Cisi).

The data firm Preqin expects the , whilst Luxembourg was home to . All of this increases the importance of valuation.

Private market evergreen funds are also on the rise, and with them, different valuation risks come into play. “Traditionally, for a closed-ended fund, the valuation risk is more front-loaded,” said Le Saux. On the other hand, open-ended funds allow entry at any times, which means that the “valuation risk is prevalent at any date.” Why is this? “If there is an over-valuation, that will mean that some of the current investors of the fund could exit at a price that’s fundamentally higher than the fair value. If there’s an under-valuation, that would mean that external investors can enter into the fund a value that’s lower than the fundamentally fair one. It creates risks for investors on all sides.”

Asset classes are “drifting,” added Le Saux, with valuation in private debt, real estate and infrastructure gaining in complexity and uncertainty. “The spectrum of risk is becoming much more blurry than it was a few years ago.”

To address these issues, regulators and global professional associations have published guidance on how to mitigate these risks. Best practices and modelling standards can help, along with education, technology, data and governance.

Increased attention to valuation

Alain Hoscheid, head of the UCI prudential supervision and risk management department at the Financial Sector Supervisory Commission (CSSF), was also present at the conference and delivered a keynote speech. “Valuation is key in the context of the function of investment funds,” he explained. “Over the last years, valuation got very specific attention of the regulators, which is mainly the result of two elements.”

The first concerns the challenges related to valuation of less liquid assets. These challenges are due to a series of successive crises in recent years, including the covid-19 pandemic, Russia’s full-scale war against Ukraine, the surge in inflation and increased interest rates. The latter in particular had an impact on “real estate markets, with lower transaction volumes and depressed prices,” said Hoscheid.

But more broadly, geopolitical developments brought also uncertainty to markets and economies. Questions “arose in relation to the use of valuation methods in private markets that may disguise potential losses, and especially also the reliance on long-term models for the valuation of underlying assets, where, in fact, there was the question: are these [models] sufficiently reactive to changing market scenarios?”

The second element that led to the “spotlight on valuation” has been the “change in the landscape of investment funds,” continued Hoscheid. There’s been an increase in alternative investment funds in general, an increase in investments in less liquid assets as well as the phenomenon of the “democratisation of alternative investment funds.” These elements have all contributed to Luxembourg, European and international regulators putting valuation “very high” on their list of supervisory work.

Valuation from the supervisory perspective

Hoscheid also provided some insights as to how the CSSF approaches valuation from a supervisory perspective.

“For us as a regulator, the overall objective of supervisory work in relation to valuation is to ensure that the different financial actors that are involved in the valuation chain--the investment fund manager, the fund, UCI administrators, but also the depositary--that these different parties comply with respective legal provisions that apply to them and respective conduct rules. But also, they have to ensure that the valuation of investments are conducted in accordance with the provisions in the offering documents. And these, just to ensure that the best interests of investors and the integrity of the market are safeguarded.”

The CSSF looks at the “whole ecosystem of actors,” he explained. They need to have adequate internal organisation, control functions, and human and technical resources. “This is, in fact, the cornerstone of reliable valuations, including also model-based valuations.”

The CSSF last year conducted a self-assessment questionnaire for funds on investment policies, said Hoscheid, presenting some results from the .  “Globally, based on the self-assessment questionnaire--so, a self-assessment, which is important--UCIs had, in fact, robust valuation policies and procedures in place for ensuring adequate valuation of the assets in which they are invested,” said Hoscheid. “That was the overarching conclusion.”

“But what we also did provide as feedback to the market is to say that we expect, in fact, the board of directors of funds--in the context of the oversight of valuation--to also formally approve the valuation policies and procedures in place for the fund, and thereby giving due consideration to the valuation risk to which the UCI is exposed to.” This is meant to ensure that boards of directors have adequate understanding of policies and procedures, allowing them to meet their oversight duties.

“Another important point--which is directly in relation also to the use of models--is that we informed the market that we would expect also the board of directors to formally approve, in fact, the use of valuation models, in the context of the valuation of investments that represent a material part of the UCI’s portfolio. The CSSF does not expect the board of directors to validate the models that are in place. It’s rather that we expect the board of directors to have an adequate understanding of the valuation methods which are used. This understanding should allow the board to have an understanding of the key features and also the main drivers, so as to enable them to be comfortable with the valuation methods.”

A “flavour” of observations made during inspections

The CSSF’s supervision is based on off-site and on-site work, noted Hoscheid. On-site work is a “building block” of the CSSF’s supervision as it allows the regulator to “make specific checks on different aspects, including also valuation.” There is a dedicated department at the CSSF that works on on-site inspections, which can include, for instance, governance or thematic aspects.

“I cannot of course give you a full list of all the observations that we observe,” said Hoscheid, who added that all the observations have to be seen in the context of the firm that was visited. But he did provide a “flavour” of what has been seen.

In relation to valuation models, “we did observe that there was missing approvals of models. We did, for instance, see cases [where] the models on the valuation of derivative structure products were, in fact, subject to an approval, with an appropriate description on it. But for instance, on the private equity, private debt, real estate side, there were not directly any approval processes in place, which is--of course--not good.”

“The second aspect which we also came across was that the valuation policies did not set up, in fact, the process underlying the changes that will be brought to models,” said Hoscheid. It’s important that those valuation policies frame these processes.

Policy updates on the horizon

The CSSF is working on a revamp of , which focuses on the authorisation and organisation of investment fund managers, with specific provisions concerning the fight against money laundering and terrorist financing. “We’ll notably have a review of chapter 6.6 on the valuation function.” In addition, the CSSF plans to “further outline, in that circular, the expectations of how models have been covered in valuation policies and procedures, and notably refer, in fact, to the rationale of using models, description of models, but also the process underlying development and validation of models.”

Valuation is--for the regulator, but I think for all of us--a cornerstone of the functioning of investment funds

Alain Hoscheid, head of the UCI prudential supervision and risk management department, CSSF

That’s at the “local” level. On the international level, the International Organisation of Securities Commissions (Iosco) last year reopened valuation principles for private investment schemes issued in 2013, said Hoscheid, as well as valuation principles for hedge funds issued in 2007. This update is being undertaken in response to market developments. Later this year, there will likely be a consultation on the new principles, with a final paper expected to be issued in 2026.

“I want to re-emphasise that valuation is--for the regulator, but I think for all of us--a cornerstone of the functioning of investment funds,” concluded Hoscheid. “The CSSF requires robust valuation policies and procedures and promotes good practices” he said. “This is to further support the trust--but also the confidence--in the Luxembourg investment fund industry.”