Can GPs' valuations be trusted?

Can you trust your fund manager(s)? 

Oxford University’s Tim Jenkinson recently found that GPs have been prone to inflating their reported interim performance data when marketing follow-on funds. Not exactly a shocking discovery, given all the anecdotes we’ve all heard over the years, but one that nonetheless remains quite important in investors’ and regulators’ quest for greater transparency and standardized reporting.

But it’s worth noting there’s a chance that the problem Jenkinson and his team identified has become less prevalent today.
            
To arrive at their findings, the Oxford team studied the California Public Employees’ Retirement System’s (CalPERS) portfolio of 761 private equity funds going all the way back to 1990, which pre-dates the Financial Standards Accounting Board’s Statement 157 (now topic 820) on fair value measurement.

Starting in late 2008, the private equity industry began marking assets to market in response to FAS-157, which left GPs a lot less wiggle-room in valuing assets with a positive bias. Amplifying the trend of valuation discipline was SEC registration, which went into effect last year and subjected most private equity firms to potential surprise inspections. The regulator has since signaled its interest in valuation in particular and its inspectors are expected to pose questions about the consistency and technique of GPs’ valuation methods across time periods.  

Oxford’s sample of funds studied included only a handful of vintages from 2008 or after; 165 of the 761 funds to be precise. 

In an email exchange, Jenkinson said no post-FAS 157 effect was discovered. However he qualified that “it may be a bit early to identify any impact of the change in accounting rules” since there was a limited amount of data from 2008 onwards. 

One would hope that as more data becomes available, subsequent studies show fund managers are much less prone to exaggerating any valuations given all the new processes and procedures that have been put in place since 2008. But in the meantime, fund managers should expect this study to fuel existing investor and regulatory concerns about inflated track records – and be ready for any resulting questions.

PS – How to get valuations right – and ensure they stand up to scrutiny – was the topic of a recent PE Manager roundtable. Our April edition includes a high-level exchange between two private equity finance professionals and a pair of auditors on valuation best practice.