Valuing private assets: Three things every investor should know
Private market valuations are inherently different to those for publicly-traded assets and reflect a longer-term outlook, which helps to explain the potential for these assets to enhance returns and lower risks for investors.
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How valuations are determined for private market investments is an important question for those considering allocating to these dynamic and fast-growing asset classes. It is also a key area of focus for global regulators looking to get more of a handle on an industry that, by some measures, now accounts for $15tn or more of global assets under management.
Here we share three important principles that every investor should understand about private market valuations, and how they relate to the fundamental potential for these assets to add return and lower risk within portfolios.
1. Valuations are fundamentally different to public markets
This one is pretty obvious – but it also goes to the heart of the value proposition for private assets.
Public market valuations are a reflection of broad investor sentiment that on a daily basis ‘prices in’ key information, both specifically about a company or asset and generally relating to the market or economy at large. These valuations are constantly compared to the wide range of comparable peers in the same investment universe.
Private market assets, on the other hand, are not traded on an exchange and there is generally no secondary market for them. There are typically few (if any) public equivalents that would act as a suitable proxy to transparently compare value. This is especially true of most ‘real’ assets in infrastructure or real estate funds, almost all private credit loans, and even the large chunk of private equity-backed companies that are smaller or that operate in more niche sub-sectors compared to their listed peers.
Moreover, the fundamental fact that public markets exist to provide liquidity – that is, the market price moves to a level at which investors are willing to buy on a given day – makes them difficult to compare to traditional private market funds, which are closed-ended and have an inherently long-term investment horizon.
In short, private market managers are charged with looking through short-term market ‘noise’ to determine the long-term value of the underlying assets they own. Their valuations are necessarily forward-looking and can be influenced to a greater extent by fundamental, asset-level developments. This helps to explain why private market performance is not closely correlated to public market asset classes (see chart), as valuations can properly reflect the potentially wider range of return drivers within these differentiated portfolios, adding to their positive diversification potential.
2. Valuations are generally less volatile
Due to the longer-term nature of private market funds, asset valuation and reporting cycles for private market funds are periodic – generally monthly for semi-liquid funds and quarterly for traditional closed-ended funds – with little to no movement between updates. Reported performance is therefore typically significantly less volatile than what we see on public markets.
This cuts both ways. Private market funds are generally slower to reflect market downturns and, as a result, when they do the maximum drawdown (or fall) can be significantly lower. As an example, see the below chart taken from our recent study of private equity market resilience during global crises over the past 25 years.
Equally, they tend to uprate assets more slowly and so can take longer to reflect upward swings on wider markets. On the positive side, this can also help to smooth volatility in the event of subsequent corrections.
During the major crises of the last 25 years, private equity has outperformed public markets with smaller maximum drawdowns
3. Valuations are robust
The fundamental differences – and reduced transparency – of private market valuations has brought scepticism in the past over to what extent investors should trust them. This is arguably most starkly reflected in private market investment trusts, many of which currently trade at prices that represent a material discount to their net asset value.
But the reality is that most private market managers employ detailed valuation processes that are in accordance with rigorous accounting standards. Assets in semi-liquid funds such as Long-Term Asset Funds (LTAFs), for example, are generally valued monthly in accordance with standards such as US GAAP and IFRS 13, and are reviewed by reputable audit firms and internal pricing committees.
More broadly, and perhaps most tellingly, many private market managers can point to meaningful uplifts in value when exiting a business or asset compared to its prior holding value as evidence that valuations are robust – and, in many cases, often conservative in nature.
To illustrate this point, the MSCI publishes an annual review of private real estate valuations that compares sales prices in actual transactions with prior market valuations for the same assets. According to its latest report, published in June 2024 and covering the period from 2000 to 2023, sales prices were 4.2% higher on average than market valuations. This means that managers of real estate assets are consistently achieving exit valuations that are meaningfully higher than their previously reported portfolio valuations based on market comparators.
Understanding the risk profile of private assets
Of course, the unique characteristics of private equity valuations – and the reduced volatility inherent to them – should not be taken as a simple reflection of the risks they represent (although there are good reasons why some private assets can be considered lower risk in general – read our recent white paper for more details).
It is also important to acknowledge that, given the nature of private market valuation methodologies, subjective considerations are inherently included in the calculations. These reflect managers’ views and interpretations of inputs including future expectations around interest rates, appropriate benchmarks and comparisons, and financial metrics within investee businesses. Ultimately, private market valuations are therefore an imperfect science and this can lead to differing valuation outcomes, even for the same or similar assets.
It’s therefore crucial that investors understand the valuation methodology and processes of managers with which they are looking to invest as part of their due diligence – and, more broadly, that they implement private markets strategically and carefully as part of a long-term asset allocation plan (read our latest white paper for more on that point). In doing so, they can look to benefit from the potential for positive diversification, enhanced returns and reduced volatility that private assets can bring to their portfolios.
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