Australian Regulator Warns Private Assets Valued Too Infrequently

Australia’s pensions regulator said some funds in the A$3.9 trillion ($2.6 trillion) industry aren’t valuing assets such as private equity and property frequently enough.

The Australian Prudential Regulation Authority said unlisted assets in some instances weren’t valued “at least quarterly,” in line with the recommendations, according to a letter published Wednesday. There was also room for improvement on the extent to which boards scrutinize the valuations of these assets, the letter said. 

Australia, home to one of the world’s fastest growing pools of pension capital, has seen an increased appetite for private assets both domestically and abroad, and they now comprise almost a fifth of their investments. Last year, some of the biggest firms told Bloomberg they’d seen write downs in their property portfolios, but said that hadn’t materially impacted members’ returns. 

APRA Deputy Chair Margaret Cole said governance around unlisted asset valuations remained a supervision priority for the nation’s regulator and the organization will continue to directly engage with funds “where weaknesses have been identified.” The greatest areas for improvement are in small to medium size funds, she said, as well as so-called platform funds which offer members a menu of investment options.  

Pension funds’ unlisted investments range from property and infrastructure, to private credit and private equity. 

“Inappropriate asset valuations, especially during periods of heightened market volatility, may materially impact prices applied to member transactions, member equity and reported investment returns,” Cole said in the letter. 

The APRA letter was based on a survey which took place in late 2023 and showed eight funds had reported instances where their board has challenged, rejected or over-ridden valuations given to them by management. For external manager valuations, that rose to 18 funds.

The survey found increased market volatility or stress was the most common reason a fund would revalue an asset and property and private equity valuations were most heavily scrutinized by boards.

The survey is separate to APRA’s review of asset valuations and liquidity management practices, which is expected to be released later this year. 

I thought I'd bring this to your attention because what is going on in Australia might soon be happening in the US, Canada and Europe.

Earlier today, Chris Addy, founder of Castle Hall Diligence, posted this on LinkedIN:

The average discount of a traded private equity fund of funds is 39%

The post below (see here) has some interesting stats regarding discounts of traded private market investment trusts (primarily UK traded by the looks of it), and raises interesting questions about valuation. This is a key observation from the post:

‣ Looking at the latest data, the average discount across all PE trusts is 23%

‣ Breaking out the results by investment strategy reveals that discounts are 12.2% for vehicles investing directly in companies vs 39.1% for funds investing in funds.

There was also a very interesting article in theThe Wall Street Journala few days ago on the secondaries space, called "Funds Are Booking Big One-Day Windfalls Buying Private-Equity Stakes".

The secondaries discussion all relates to an accounting loophole:

The accounting standard ASC 820 defines "fair value" as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price)."

But, there is something called the "practical expedient" which states that an investment fund NAV is only "fair value" if it is both "published" and is the "basis for current transactions".

Pretty much no private, closed end fund (PE, venture, real estate etc) falls under this definition. The NAV is usually not published (public) and it's easy to argue that, while there are current transactions in the secondaries space, the secondaries market is not the "basis" for a transaction that a specific investor would use today if there is no compunction to sell.

As such, investors don't have to say that the fund is "fair valued" but can instead say that the NAV is a "practical expedient", provided they have completed due diligence to confirm that the underlying fund is valuing assets in accordance with ASC 820. In practice, that usually means that if the underlying fund is audited, then the investor is good to go at 100 cents on the dollar.

All sounds good - but it's a tough situation to reconcile.

Per the WSJ, Hamilton Lane bought a stake in the Blackstone Tactical Opportunities Fund II fund at a 39% discount.

- If the seller didn't sell all their position in Tac Ops II, will they keep the remaining portion at 100c or at 61 cents?

- If the seller owns Tac Ops III, for example, are they valuing that at 100c - even though they just unloaded fund II at a 39% discount?

- If the buyer adds Tac Ops II at 61 cents...are they comfortable that this position is really worth 100 cents?

This is ultimately a question of governance for institutional investors. As "extend and pretend" comes to an end, will it turn out that the values ascribed to secondary market transactions are closer to "fair value"? Then what happens to asset allocation, actuarial assumptions around plan funding levels....

There are lots of discussions going on right now about how private equity funds aren't selling assets because they know they're going to suffer a significant haircut and this is pissing off LPs as they want them to clear their books and move ahead to focus on new investments

This lag in valuations isn't helping anyone and sooner or later, GPs will have to sell (weaker funds first) and valuations will reflect true economic valuations.

But make no mistake, LPs are putting the pressure on GPs who are forced to respond:

“GPs are looking to find ways to bridge the gap either on valuation or raising capital for new deals, which makes continuation funds an attractive tool to do so, although we’re starting to see more positivity on take private and go to market transaction in that regard,” says Macarchuk, adding that GPs are becoming more creative with private credit offerings to create value for LPs.

That shift is supported by Coller Capital’s latest Global Private Equity Barometer report, which found that 44% of private equity investors expect to raise their private credit allocations over the next 12 months. Similarly, co-investment deals, which are becoming more commonplace, are also more attractive to investors, according to Coller Capital’s findings. Many PE managers have also altered their focus to profitability within their portfolio companies versus growth.

One major driver of the shift to less traditional PE deals has been paltry M&A activity. In the wake of an ongoing disconnect between buyers and sellers regarding company valuations, the number of M&A exits for PE firms has been minimal, with roughly 75% of sell-side deals in 2023 failing to come to fruition, according to Macarchuk. Pitchbook data shows there were only 170 middle-market deals completed in Q3 2023, down nearly 75% from 2021 when there were around 600 exits per quarter and still well below pre-pandemic activity levels in 2019 when there were an average 300 to 350 deals completed per quarter.

One thing is for sure, high interest rates have slowed dealmaking and distributions, reducing the amount of capital GPs can commit to their own funds. In addition, high rates could discourage GPs from leveraging loans to finance their commitments.

Add to this more regulatory scrutiny on how frequently private assets are valued and you get more fuel on the fire plaguing the industry right now.

And again, let me be clear, I expect elite funds to continue doing well as they can absorb the costs of more regulations, the smaller funds will find it more challenging.

Below, the private equity industry must face up to the reality of lower valuations, according to Apollo Global Management Inc.’s Scott Kleinman.