Overcoming Valuation Obstacles in Private Equity and Private Credit
These concerns which were outlined in a recent article from Delano and are also echoed by the US Securities and Exchange Commission (SEC).
Austin Brady, Product Lead – Credit and Research at Waystone, explains how through our team’s deep valuation expertise and an AI-driven valuation platform, Waystone is at the forefront of assisting clients to address these challenges, providing accuracy and transparency in private equity and private credit valuations, and enhancing regulator and investor confidence.
Addressing Valuation Challenges
1. Lack of Observable Market Prices
One of the primary challenges in valuing private equity and private credit is the absence of directly observable market prices. Unlike public markets where prices are readily available, private assets require assumptions and projections to estimate value. This subjectivity can lead to inconsistencies and inaccuracies in Net Asset Value (NAV) calculations. For instance, infrastructure projects or other illiquid investments might take weeks to value and still leave an impression of arbitrariness.
“The AI-driven valuation model used by Waystone leverages data from more liquid markets to provide accurate and real-time valuations for private assets. This approach reduces the subjectivity inherent in traditional valuation methods, ensuring a consistent and reliable estimation of NAVs,” says Austin.
2. Outdated Practices and Methodologies
The CSSF has identified outdated practices and methodologies as significant issues. These practices often lack the robustness needed to withstand the dynamic nature of market environments. Valuation policies with some fund managers are insufficiently detailed, leading to gaps in compliance and potential inaccuracies.Austin comments, “By leveraging data from more liquid markets, the valuation model not only addresses these gaps but also ensures that valuations are accurate and reflective of real market conditions. This robust approach allows for transparent price evolution, providing a clear audit trail and increasing investor confidence.”
“The AI platform continuously updates its methodologies to align with the latest market trends and regulatory requirements.1 By automating and refining these processes, Waystone ensures that valuation practices remain robust, relevant and compliant, eliminating the gaps identified by the CSSF.”
3. Inadequate Role Definition and Oversight
Another concern is the lack of clearly defined roles and responsibilities in valuation processes. The CSSF emphasizes the need for independent review and periodic reassessment of valuation models to ensure they remain relevant and accurate. This gap in role definition can lead to inadequate oversight and control, further exacerbating valuation challenges. Emphasizing the use of cutting-edge technology, Waystone ensures that valuation practices remain at the forefront of industry standards. The tool is continually reviewed, ensuring that it adapts to evolving market conditions and regulatory requirements. This commitment to continuous updating is vital in maintaining the relevance and accuracy of valuation methodologies.
Austin notes, “Waystone’s platform incorporates a comprehensive oversight mechanism, ensuring that all roles and responsibilities in the valuation process are clearly defined and independently reviewed. This structure enhances accountability and accuracy in valuations.”
4. The Complexity of NAV Calculation for Different Fund Types
NAV errors can have different implications depending on the type of fund. Open-ended funds, which allow daily investor transactions, are particularly sensitive to NAV inaccuracies, potentially leading to inappropriate payments and the need for compensation. Conversely, closed-end funds, typical in private equity, calculate NAV less frequently, reducing the immediate impact of valuation errors but still necessitating rigorous accuracy. Austin says, “By leveraging data from more liquid markets, the valuation model not only addresses these gaps but also ensures that valuations are reflective of real market conditions. This robust approach allows for traceable price evolution, providing a clear audit trail and increasing investor confidence.”
Austin explains, “The Waystone valuation offering, within Private Credit and Private Equity, for example, supports high-frequency NAV calculations, especially for open-ended funds, providing timely and accurate NAV reporting. This capability mitigates the risks associated with NAV errors and ensures compliance with regulatory standards.”
5. Market Concentration Risks
Another significant risk in the private credit market is market concentration. With a few large players dominating the market, the potential for systemic risk increases. If one of these dominant entities fails, it could have far-reaching consequences for the entire market, amplifying the financial instability. Waystone’s solution incorporates advanced stress testing and predictive analytics. These features allow fund managers to forecast potential risks and outcomes under various scenarios, aligning valuations with both macroeconomic factors and real-life results. This predictive capability is crucial for proactive risk management and strategic planning.
“The AI tool monitors market concentration risks by analysing market data and providing insights into the exposure and impact of dominant players. This proactive approach helps in identifying and mitigating potential systemic risks,” Austin states.
6. Opacity in Asset Valuations
Opacity in how private credit assets are valued is a major concern. The lack of transparency can obscure the true risk profile of these assets, making it challenging for investors and regulators to assess potential threats accurately. This hidden risk can lead to significant valuation discrepancies and undermine investor confidence.
One of the critical improvements Waystone brings is transparency. The AI tool enables daily or ad hoc valuations, moving away from the traditional quarterly or annual assessments. This high-frequency valuation capability ensures that stakeholders have up-to-date information, facilitating better decision-making. Additionally, comprehensive analytics and reporting features allow for detailed credit risk profiles and company-specific insights, beyond just fund-level information.
Austin says, “Transparency is at the core of the valuation platform. By enabling daily or ad hoc valuations and offering detailed analytics and reporting, we ensure that asset valuations are transparent and accessible, thereby enhancing investor confidence and regulatory compliance.”
Valuation challenges in private equity and private credit are not confined to Luxembourg; they are a global concern. The complexities and subjectivities involved in valuing illiquid assets necessitate robust, transparent and innovative solutions.
“Waystone’s expertise and advanced AI-driven valuation tool represents a significant step forward in addressing these challenges, ensuring accurate, timely and reliable valuations that meet both regulatory standards and market expectations,” says Brady.
By adopting such innovative solutions, the private equity and private credit sectors can enhance investor confidence, improve compliance and ultimately contribute to a more stable and transparent market environment.
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1 Experts on the valuation team use market intelligence to constantly improve the model to ensure the most accurate information is used in valuations. This ensures that user input is regularly required to make improvements through business and credit cycles.