Private Equity Says Its Fund Values Don’t Come From Dartboards

(Dreamstime)

With the federal government considering whether to encourage 401(k) retirement plans to include private assets, one concern is knowing what those investments are worth.

The value of a stock and bond portfolio is clear, from moment to moment, but what about a bunch of real estate, private loans, and private companies? If some of the $12 trillion in retirement accounts will go into such investments, the calculation of returns, payouts, and fees will depend on reliable valuation.

Some think that private valuation is like throwing darts at a dartboard. That couldn’t be further from the truth, said Craig Lewis, a Vanderbilt University finance professor who previously served as chief economist at the U.S. Securities and Exchange Commission. He joined a couple of dozen other experts to discuss the elaborate procedures used to value private assets in a Thursday morning roundtable sponsored by the Wall Street industry association Sifma.

Private-fund managers get updates from the businesses and properties they own. Third-party data services help compare those holdings to others in the same industry. Auditors test the fund company’s work. In the last decade, private managers have gone from valuing portfolios quarterly to valuing them monthly and even daily.

A few trends are driving these pricing improvements, said Cindy Ma, who runs portfolio valuation services at the investment banking firm Houlihan Lokey. Instead of waiting for a private-equity fund to wind down, big investors now sometimes trade their piece of a fund to another big investor. Funds are also borrowing to leverage returns or raise cash, and lenders want to know what a portfolio is worth.

Daily values of real estate portfolios have been calculated for the past 20 years at asset manager PGIM, said Sara Shean, who runs its defined contribution retirement fund business.

The valuation estimates for private assets are going to be less precise than for stocks and bonds because there is less information available, said Vanderbilt’s Lewis. But public market values aren’t certain either, he noted. Fixed-income funds can arrive at different conclusions about the same publicly traded bond. Stock analysts vary in their price targets.

For retirement savers, worries about the pricing of private holdings would be mitigated by several things. The vehicles where private assets show up will likely be target-date funds with longtime horizons before their investors cash out. Private assets will be a small percentage of a professionally managed portfolio, with plenty of other liquid assets available when retirees need to cash out.

Government regulators don’t want 85-year-olds to be asked to put everything into fourth-tier private investments that everyone else has passed on, SEC Commissioner Mark Uyeda told the roundtable.

“That’s not what we’re talking about, and we have regulations to guard against that,” he said.

Write to Bill Alpert at william.alpert@barrons.com