6 minute read 28 Apr. 2020
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How COVID-19 impacts investment fund asset valuations

Authors
Christophe Vandendorpe

Leader, Strategy and Transactions, EY Luxembourg

Trusted transaction advisor for M&A, due diligence, valuations, legal entity rationalization. Team player. Results-oriented.

Michael Ferguson

Partner, Wealth and Asset Management Industry, Ernst & Young S.A.

EY Partner. 30 + years’ experience in the Wealth & Asset Management Sector. Vice Chairman of the Luxembourg Investment Funds Association (ALFI).

Richard Gray

EY EMEIA Wealth and Asset Management Transactions Leader

Transaction advisor to the wealth and asset management industry, specializing in due diligence engagements, IPOs and corporate finance advice.

6 minute read 28 Apr. 2020

Asset managers need to proactively consider valuation challenges arising from the COVID-19 pandemic's effect on financial markets.

The 2008 financial crisis highlighted that there was insufficient management of liquidity and excessive risks in the industry. As a result, firms started more closely monitoring their investments, diversifying portfolios and increasingly focusing on their governance structure.

Such measures were thought to provide increased resilience in the event of future market turmoil. Despite this, new challenges have emerged as a result of the uncertainty arising from the COVID-19 pandemic.

Financial markets reacted to the pandemic by plummeting and highly volatile stock markets and increasing credit spreads. We have seen a significant reduction in the liquidity of many asset classes, postponed M&A transactions and the temporary closure of small financial markets. These factors lead to significant pressure on fund liquidity as investors look to redeem or reallocate holdings.

As a response, asset managers have started to take significant protective measures, as illustrated by the recent decision from well-known asset managers to gate or suspend open-ended real estate investment funds to ensure equal treatment between investors.

Regulators across the globe have started asking asset managers for additional information. Both the Irish and Luxembourg regulators have been investigating the ability of investment fund managers to meet large investor redemptions and have imposed additional reporting requirements, whilst the SEC has asked whether funds have experienced any delays in, or concerns with, pricing services providing daily prices.

 

The first priorities for asset managers have been the health of their workforce, and to ensure that operations can continue. Secondary to this, but nevertheless an important topic, is assessing the impact of this pandemic on the valuations of their investment funds’ portfolio assets, as well as ensuring sufficient liquidity.

In light of the COVID-19 pandemic, asset managers should address the following six key issues when it comes to the valuation of investment funds’ assets:

1. Valuation policies and guidelines

Various external sources (such as International Valuation Standards (IVS) and the International Private Equity and Venture Capital Valuation (IPEV) guidelines) provide guidance as to how to deal with volatile or illiquid markets. Nevertheless, it may be appropriate to reconsider the valuation approach, for example in circumstances where information from recent transactions is not reliable.

2. Financial models and business plans (of particular relevance to unquoted assets, private equity, real estate, infrastructure, etc.)

The business plans are an important input to value measurement. How should the business plan assumptions be reassessed considering the current economic environment? Do the financial models for valuing your portfolio investments appropriately capture stressed liquidity scenarios? How are your portfolio companies protecting their business and do your valuation assumptions remain reasonable?

3. Valuation of illiquid assets

Illiquid assets are frequently valued based on recent comparable transactions. Since the COVID-19 outbreak, most transactional activity has been postponed and past transactions may no longer reflect current market conditions. How should value be assessed then? Is it reasonable to assume a return to ‘normal markets’ and, if so, when?

4. Valuation for funds of funds

For most investments in other funds (such as private equity fund of funds), the previous quarter’s NAV of those funds is frequently adopted for the fund itself. How should the fund recognize the COVID-19 impact in its reporting for 31 March 2020 and adjust the reported NAVs as at 31 December 2019 appropriately?

5. Valuations for financial reporting as at 31 December 2019

How should the impact of the COVID-19 pandemic be appropriately addressed and included in your financial statements as a post balance sheet event to keep these from being misleading?

6. Valuation opportunities

Is the current environment offering an opportunity to take a critical look at some assets and take the appropriate impairment decisions?

Three business cases to consider:

Quarterly portfolio valuations

The typical approach to valuing unlisted investment portfolios on a quarterly basis is to consider recent comparable transactions at each quarter, and then use the data identified to calibrate the valuation to the previous quarter and/or transaction date. Since the outbreak of the COVID-19 pandemic, the market data is either unavailable, unreliable or stale, and as such may not be relevant for the purposes of the quarterly valuation process.

Fund of fund investments

For fund of funds, many asset managers tend to rely on the valuations included in the NAV provided by the fund they invested in. These valuations are usually not contemporary with the NAV date and frequently based on the underlying funds’ past quarter NAV. We understand that for those fund of funds that are reporting as of 31 March 2020, when the impact of the pandemic struck the markets, the NAVs available to them from their fund investments are often pre-COVID-19; in particular for illiquid funds, these NAVs are typically based on 31 December 2019 (or older) valuation dates. As at those dates, and even as of the end of February 2020, the impact on the markets was less pronounced. Whilst the impact on the listed investments can easily be verified, for unlisted investments this is less straightforward.

Financial models and business plans

The current social distancing requirements, combined with economic concerns are harming companies’ revenues, profitability, cash flows and liquidity. Most organizations are faced with uncertainty in relation to their business modelling scenarios that in this environment play a key role in making decisions, provided the models are based on valid assumptions and associated risks are properly evaluated. In order to navigate this uncertainty, decision makers need a set of forecasts, scenarios and models for operational, reporting and future investment purposes.

Summary

COVID-19 creates major uncertainty and asset managers need to consider if the valuations of funds used are sufficiently robust to produce a reliable NAV. A sustainable approach will be needed for what may be an extended period of disruption. We recommend careful documentation of key decisions so that an audit trail can be produced in the event of any later enquiries. Download Impact of COVID-19 on investment fund asset valuations (pdf) for more information.

About this article

Authors
Christophe Vandendorpe

Leader, Strategy and Transactions, EY Luxembourg

Trusted transaction advisor for M&A, due diligence, valuations, legal entity rationalization. Team player. Results-oriented.

Michael Ferguson

Partner, Wealth and Asset Management Industry, Ernst & Young S.A.

EY Partner. 30 + years’ experience in the Wealth & Asset Management Sector. Vice Chairman of the Luxembourg Investment Funds Association (ALFI).

Richard Gray

EY EMEIA Wealth and Asset Management Transactions Leader

Transaction advisor to the wealth and asset management industry, specializing in due diligence engagements, IPOs and corporate finance advice.