With private market valuations under scrutiny as volatility roils their public market counterparts, Preqin’s Alternative Assets H1 2023 Investor Outlook included some illuminating highlights:
- Investors expect more write-downs on worsening private equity performance over 2023. Despite this, almost a third (31%) of survey respondents still expect to commit more capital to the asset class. Only 13% said they would commit less.
- 35% of respondents expected an imminent correction in venture capital valuations – and this was before the collapse of Silicon Valley Bank and its ripple effect on the sector.
- 74% of investors felt real estate assets are overvalued as performance declines.
- Just under three-quarters of respondents said private debt assets were either undervalued or fairly valued. In infrastructure, the figure was 65%.
Even with the current macroeconomic headwinds and valuation concerns, Preqin noted that “investors believe alternative assets will continue to play a significant role in their portfolios,” with 35% of the survey respondents planning to increase their overall private capital investments over the next 12 months.
Private market valuation arguments
But are private market investment valuations really out of kilter?
AQR Capital Management co-founder Cliff Asness has been a prominent critic of PE’s lack of mark-to-market valuations, warning of valuation “volatility laundering” by private market funds leading to unrealistically smoothed returns.
Concerns that infrequent private market NAVs significantly lag the public markets, and may be hiding significant depreciations, have incited Two Sigma to update its Venn risk management and portfolio analytics platform to address the issue. In January, the firm launched a new private asset analytics feature designed to “de-smooth” private market performance and mark it to market.
By looking at infrequent and smoothed private asset performance and appropriate public market proxies, Venn’s desmoothing option seeks to reduce private market performance lag, according to the firm’s announcement. In addition, Venn’s existing interpolation functionality aims to increase the frequency of private market returns using a relevant public market proxy “to create an approximated daily return stream for the private asset.” This process, the firm said, “enables allocators to quickly convert quarterly private asset returns into a daily return series that resembles a marked-to-market public return stream.”
Valuation fears overblown?
Private markets investment manager Hamilton Lane argues though that most private equity holdings are appraised conservatively and should hold their value.
The firm’s latest Market Overview data shows private market valuations in most sectors began 2022 at a significant discount to comparable traded assets. Valuation multiples for public and private equities then converged over the course of the year. Operating performance outstripped comparable listed assets, with managers tending to exit deals at a premium to reported value.
And private market assets not only beat public strategies across the board in 2022 – in some cases “by thousands of basis points” (for example, buyout outperformed the S&P 500 by nearly 2,050 bps) – but have fared better during other recent downturns, demonstrating significant outperformance during periods of stress.
“These factors suggest that, at the current time, there is not any blanket over or under valuation of private assets, dispelling the narrative that private markets valuations are overstated today,” the Hamilton Lane report said. The firm predicts that private credit, secondaries and infrastructure in particular will provide compelling opportunities in the year ahead.
Cyril Demaria, an affiliate professor for private capital at EDHEC Business School, supports such arguments. He contends that private market fund NAVs no longer significantly lag the evolution of public markets, and are adjusted upwards and downwards in a similar fashion to listed indices.
The ebb and flow is more muted than in public markets, which “overreact to information, and can diverge substantially and durably from their fundamentals,” Demaria contended. By contrast, “private fund managers are prudent when assessing their holdings, both on the upside and the downside. As a result, the NAVs move more sedately than stock markets”.
But valuing private companies based on similar PE transactions and comparable listed deals — the recommended method – means improving the transparency of information on those transactions by upping the quality and granularity of the data surrounding private investments is essential, Demaria added.
Clear valuations then need to feed into transparent performance metrics to help investors benchmark the return on investment of their private market holdings against other asset classes.
In a future piece we’ll take a look at the calculations we believe are crucial for investors to gain a complete picture of a fund’s performance.
Important notice
This content is for information purposes only. Treble Peak does not provide investment or tax advice, and information on this website should not be construed as such. Potential investors should seek specialist independent tax and financial advice before investing in any alternative investment. Past performance is not a reliable guide to future returns. Your capital is at risk
