How are illiquid assets valued?
Low interest rates have made private assets more popular to investors, but how are illiquid assets valued?
The current low interest rate environment has increased the trend of KiwiSaver fund managers looking to invest in private assets alongside the more traditional vehicles of listed shares and traded bonds.
While these ‘illiquid’ assets may provide higher, or more consistent, returns in the long-term, a change in investment strategy means taking a different approach to managing the funds and ensuring the correct principles are applied when the assets are valued, says Andrew Hughes, Public Trust’s General Manager, Corporate Trustee Services.
Over recent years, private – or illiquid – assets have represented less than 5% of those held in a KiwiSaver fund. However, with ongoing economic change in all markets, this ratio is likely to grow towards 10% and possibly higher as managers seek to maximise returns on their investors’ funds.
Private assets are investment opportunities that are unavailable through public markets. They typically comprise venture capital entities, private companies, direct property and loans secured by property.
Given the illiquidity of private assets, they will take longer to sell than listed shares and the price will need to be negotiated between the buyer and seller.
KiwiSaver funds are valued each day and the fund’s unit price is then used to process members’ applications and withdrawals. The value of a private asset is important to this process and it needs to be fair to all members investing in a fund, including those withdrawing and those who remain in a fund.
In May 2013, the International Organization of Securities Commissions (IOSCO)* developed the Principles for the Valuation of Collective Investment Schemes (referred to in New Zealand as Managed Investment Schemes or MIS).
These principles were referenced in the MIS manager valuation and pricing practices released by the Financial Markets Authority in December 2018. In applying these principles to the valuation of private assets, KiwiSaver fund managers should ensure:
valuations are determined in good faith and the valuation process is consistently applied;
policy and procedures are in place for valuing each type of asset which could include inputs, models and the selection criteria for pricing. This should include the frequency of valuation and which circumstances would require additional valuations, such as significant changes in values of listed shares and traded bonds between valuations of the private assets;
conflicts of interest are considered and there should be reviews of valuations independent of the investment team involved in any valuation;
the policy and procedures should be independently reviewed annually to ensure they are still appropriate; and
the valuation methodology is appropriately disclosed to members as part of the Manager’s Disclose Statement or on the fund manager’s website.
Governance around the valuation process is equally important and an independent pricing committee should be set up to oversee this process.
The auditors will also need to be satisfied with the valuation of the private assets.
“The valuation of any financial investments, including private assets, should be underpinned by a formal valuation policy which has been approved by the fund manager’s governing body,” Financial Services Partner at PwC Phil Taylor says.
“This valuation policy should establish a consistent and transparent process for determining the valuations of all financial investments and addresses: valuation principles; the responsibilities of any “valuation” related committee or governing body; the guidelines to follow including the frequency of valuations; and the process timelines.
“Specifically, for the assumptions and judgements that form the basis of the valuation of any private asset, these should be reasonable and supportable, including external benchmarking to comparable investment prices and a full valuation history for each asset which will continue to be built up over time.
“Overall, it is important to retain documentation that supports the valuation process undertaken and how the reported valuations were determined, along with supporting evidence.”
General Manager, Corporate Trustee Services at Public Trust Andrew Hughes says, “we expect the private assets within KiwiSaver schemes to grow and for the approach to valuing these assets to keep pace with this growth. Private – or illiquid – asset valuations need to be treated differently from other types of investment assets in order to be fair to all KiwiSaver scheme members.”
Notes: Public Trust’s Corporate Trustee Services supervises 13 of New Zealand’s KiwiSaver schemes, with over $30 billion funds under supervision.
*International Organization of Securities Commissions is the international body that brings together the world’s securities.
