LPs should question GPs on asset valuations: report

'There are enough yellow and orange flags, if not red flags, that show valuations may not reflect what an orderly market transaction should reflect.'

Private equity managers have been slow to mark down asset valuations and may not be accurately reflecting the reality of the broader economy, according to a report from Equable Institute.

Private equity valuations lag public markets by several months. The latest round of marks date to the end of June and have exceeded expectations, which led some LPs to doubt their accuracy.

“There are enough yellow and orange flags, if not red flags, that show valuations may not reflect what an orderly market transaction should reflect,” said Equable Institute executive director Anthony Randazzo.

Equable Institute is a non-profit, bipartisan organization that focuses on improving the long-term financial security of public pension systems.

Both the leading investment officers at Harvard Management Company, manager of Harvard University’s endowment, and Alaska Permanent Fund, recently questioned GP asset valuation marks.

GPs have sole discretion over recording valuations over their private assets and lean conservatively on these results. Sources have pointed out that, while marks generally have only fallen slightly as of the second quarter, they expect deeper write-downs over the next few quarters. Write-downs and write-ups happen over a series of quarters, rather than in one dramatic shot, sources have told affiliate title Buyouts.

Since the start of the year, the Russell 3000 Index – used by some as a proxy for private equity funds – has dropped by 21 percent.

“There is a really wide divergence between public market performance and private markets. None of this is saying that there is clear fraud happening. But reasonable pension systems should be asking hard questions to the managers they allocate to,” Randazzo said.

Harvard CEO NP Narvekar wrote in the endowment’s report for the past fiscal year that he expects private asset valuations to adjust at the end of the calendar year once portfolios are officially audited.

“It would be discouraging if it takes end-of-year auditor remarks for funds to mark down their assets. I can understand some level of hesitation to not mark things down more than they could be. But the incentives private equity managers have to be slow in markdowns are not the same as pension funds, which need to have their portfolios accurately measured at the end of fiscal years,” Randazzo said.

According to Equable Institute, many public pension systems reported private equity returns of 20 percent or more during fiscal year 2022.

“Pension funds manage money on behalf of public employees and taxpayers,” Randazzo said. “This demands a lot of transparency and that is not something the private equity industry loves. There’s already enough friction between how private equity investing works and how pension funds should be operating to raise questions.”