A good value option

Some private equity firms are forking out large sums of money for third-party portfolio valuation services – which are neither a regulatory requirement nor an LP concern.

A pfm poll of LPs, coupled with evidence presented at last week’s British Private Equity and Venture Capital Association Summit in London, indicates investors would much rather portfolio valuations be done independently – but by an in-house team – to save both time and money.

“Independent [third-party] valuations are expensive, and not timely, so you have to question their real benefit,” Mark Drugan, managing director at Capital Dynamics, tells pfm.

This is a view echoed by a number of other LPs. There is also concern the third-party valuers don’t have the requisite depth of knowledge – beyond the spreadsheets – to make a proper assessment of an asset’s value.

A valuer needs a deep understanding of an asset, its management team, the way the company is operated, and the technology it uses. When you outsource that to a third party, much of its conclusion is based on assumptions. You can’t necessarily produce an accurate valuation based solely on figures.

So why have some private equity firms taken the decision to outsource portfolio valuation? It stems from an interpretation of the Alternative Investment Fund Managers Directive.

The directive obliges fund managers to produce independent portfolio valuations at least once a year, as well as before launching a new investment strategy or engaging with a different type of asset. Some have taken this to mean valuations should be outsourced, when in fact they can be done internally, provided the task is completed by a team independent of the fund management group. This means they don’t report into the same manager as the deals team.

There are, of course, instances in which third-party valuations are preferable. Fund managers usually err on the side of caution when it comes to pricing their holdings; external valuers tend to be more generous. For this reason, for certain funds – typically infrastructure – where you have a longer lifespan and carry based on yield and valuation rather than exits, there is a strong case for the use of a third-party service.

But in general, for private equity firms at least, it seems an internal valuation process is sufficient.