Direct investments
May 13, 2021

Private market valuations: Mirror, mirror on the wall, what’s the ‘fairest’ of them all?

May 13, 2021
Kwei-Min Braumuller
Head of Operational Due Diligence - Europe, Middle East & Africa & Asia Pacific
Ambitious woman looking out of window

Strong valuation policies, good governance, sound methodology and robust procedures have become ever more critical in the wake of uncertainty and fluctuating asset pricing created by the COVID-19 pandemic.

The Cambridge Dictionary defines the term ‘valuation’ as ‘the act of deciding how much money something might be sold for’. Pretty straightforward one would say. So why is there so much debate around the valuation of assets, in particular within the private markets industry?

Discrepancies in the valuation of an asset are often driven by the inherent conflict of interest between buyer and seller when determining an asset’s ‘fair value’.

Fair value is commonly defined as ‘the price that would be received to sell an asset, or paid to transfer liability, in an orderly transaction between market participants at a specific measurement date’. In addition, it is important to determine how the fair value of an asset has changed between valuation points.

So in the absence of a ‘magic mirror’, how can investors ensure that investment managers are applying the ‘fairest’ value to an asset?

We believe that effective valuations are based on four key elements: policy, governance, methodology and independence.

It is important for an investment manager to have a documented valuation policy that embodies the concept of fair value.

A documented policy establishes accountability and allows for consistency of implementation, while addressing potential conflicts of interest. The policy should be based on recognized accounting standards, and define the valuation methodologies used to value each type of underlying asset. It should describe the roles and responsibilities of the relevant governing bodies and the individuals responsible for valuing the assets.

It should also establish formal processes for escalation in the case of any disagreements.

The valuation committee is typically the primary governing body responsible for the oversight and implementation of the valuation policy, and its role should be to ratify the valuations. It should ideally be comprised of a majority of non-investment personnel and meet at a frequency commensurate with a fund’s reporting cycle. The committee should also ensure that valuation decisions are documented.

Where investment managers lack a valuation policy or valuation committee, Citi Private Bank’s Operational Due Diligence (ODD) team requests that these formally be established.

For example, in the case of an EMEA based real estate advisor where there was no formal, documented policy outlining the process for valuing assets.

A number of industry recognised valuation guidelines provide the methodologies for determining the fair valuation of private or less liquid assets.

Within private markets, the most widely used guidelines are the International Private Equity and Venture Capital (IPEV) valuation guidelines and the American Institute of Certified Public Accountants (AICPA) guidelines. In addition, industry bodies such as the Alternative Investment Management Association (AIMA) provide guidance around the governance of the valuation process.

It is said that ‘victory lies in a multitude of counsellors’. By the same token, valuations are best determined as a joint effort between the investment manager, who is most familiar with the asset, and an external valuation adviser, independent of the investment manager. The valuation adviser will typically validate the valuation conclusion through a review of the valuation model and inputs (‘positive assurance’) or corroborate the valuation conclusion through a series of values (‘range of values’).

In addition, back-testing can be used to determine the effectiveness of the valuation of an asset over time.

Where the valuation process lacks input from an independent valuation adviser, ODD will work with the investment manager to ensure the implementation of appropriate valuation processes and controls, for example, in the case of a prominent real estate investment firm in North America where ODD requested the engagement of a third party to value the assets on a regular basis.

All well and good under normal circumstances, but no magic mirror could have predicted the impact of the coronavirus pandemic on global markets in 2020.

The COVID-19 pandemic created an unprecedented level of uncertainty among GPs and LPs alike, with questions around private asset valuations often taking centre stage.

At the start of the pandemic, we saw a temporary shift in focus, from unrealized valuations to ensuring the stability of investment portfolios. In addition, we saw GPs cancel or postpone third party appraisals, where possible.

However, the pandemic has further underlined the significance of good governance around valuations, and strong valuation policies and procedures in times of uncertainty.

It has also shown the importance of providing LPs with the right level of disclosure when it comes to the rationale behind a GP’s valuation inputs and assumptions, and any deviations from existing policies.

At Citi Private Bank we focus on the above key elements when assessing the valuation practices of investment managers in order to reduce the operational risks associated with the asset valuation process and protect our clients’ assets.


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