Swiss-based fund of funds manager Unigestion has come up with a new way for LPs to quantify risk in private equity.
Unigestion, alongside technology institute Ecole Polytechnique Fe´de´rale de Lausanne, has developed a proprietary framework based on the difference between expected cash flows and actual cash flows.
Typically, risk assessments are based on GPs’ interim valuations or exit multiples. But Unigestion argues that these do not truly reflect private equity risk – because valuations are too subjective and relying on exit multiples takes too long.
“We started this exercise by asking ourselves ‘what is for us the true risk when building a portfolio of funds?’ and the answer for us is that the true risk is that we don’t receive distributions back as expected in terms of timing and in terms of amount,” Christophe De Dardel, executive director and head of investment mandates at Unigestion, told PE Manager.
“When we answered that it became very clear that the risk measures based on the interim measures are not bad but are not addressing our need.”
The study said that by using Unigestion’s risk measure – known as Expected Cumulative Downside Absolute Deviation – LPs see results in a single number, allowing for an easy comparison between funds. Additionally, it can be applied to either a single fund or to groups of funds.
Investors are increasingly looking at new methodologies to assess the track record of private equity firms and assign general partners (and industry sectors) a risk profile, a large European LP previously told PE Manager.
“There is a very clear need for improved risk assessment in private equity portfolios,” said Hanspeter Bader, managing director and head of private assets at Unigestion.
Unigestion’s research was based on the cash flow data of 1,402 funds and approximately 88,000 individual investment cash flows spanning from 1996 to 2012, sourced from Preqin.