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The growing interest in semi-liquid funds presents unique challenges for alternative investment fund managers (AIFMs). These challenges formed the foundation of discussions at the recent roundtable organized by EY Parthenon Luxembourg, which brought together a distinguished group of 20 professionals representing AIFMs and depositary banks. In a deep dive into the critical topic of valuation oversight for AIFs, best practices, emerging trends and the challenges that lie ahead, industry thought leaders offered a rich perspective that could shape the future of valuation in this dynamic sector.
EY Parthenon Luxembourg: valuation roundtable
Current challenges in semi-liquid funds
Deploying capital in the alternatives industry is fraught with difficulties, particularly concerning liquidity management, as mentioned by participants at the roundtable. The complexity of managing investments that may not be readily liquidated requires robust operational frameworks and innovative solutions. One key instrument for liquidity management is the lock-up period, however implementing such measures can be costly and complex, especially when considering the diverse interests of different clients.
Investors in semi-liquid funds are diverse, ranging from retail investors to high-net-worth individuals and institutional clients. This diversity increases competition among funds, making it imperative for AIFMs to develop clear and transparent valuation frameworks that build trust with investors.
A primary concern is the valuation of illiquid assets. Participants emphasized the significant risks associated with valuation misstatements and the need for accurate net asset values (NAVs). Investors are demanding greater transparency and frequency in valuations, necessitating a shift from traditional annual assessments to more regular updates. This evolution is particularly pertinent for open-ended illiquid strategies, where discrepancies can lead to investor dissatisfaction.
Valuation function challenges
Valuation functions face numerous challenges, including the inherent illiquidity of assets, which complicates the establishment of accurate valuations. According to the participants, the most significant challenge in valuing illiquid assets is the illiquidity itself, as indicated by the majority of participants. This complexity is compounded by requests for greater frequency of valuations, which can lead to operational challenges and potential errors as fund managers strive to keep pace with investor demands, particularly given difficulties with access to reliable information in a timely manner.
The challenge lies in balancing the frequency of valuations with their associated costs. Fund managers must evaluate whether the benefits of more frequent valuations justify the expenses incurred, especially when dealing with illiquid assets.
The participants highlighted that limited access to reliable data can lead to inaccurate valuations and increased risk, emphasizing the need for improved data management practices. Moreover, the increased volatility of public markets poses additional risks for asset managers. One of the primary reasons for the existence of private markets is to protect investors from the volatility associated with public markets. Consequently, it is becoming increasingly difficult to tag the value of illiquid assets directly to indexes.
At the same time, participants emphasized the importance of backtesting the previous forecasts and valuations against the actual figures and transaction prices when exits occur, as this practice can be a valuable tool for valuation professionals.
Some participants raised questions about the necessity of increased NAV frequency for investors. While it's evident that many investors favor more frequent valuations, there remains uncertainty about whether all investors fully understand the costs and risks associated with this higher frequency. This lack of awareness may lead them to reconsider their demand for more frequent valuations.
The importance of liquidity management
Liquidity management is a critical aspect of operating semi-liquid funds. Discussions highlighted the need for effective liquidity management tools and liquidity stress testing to navigate the complexities of illiquid investments. Fund managers must carefully consider lock-up periods and other mechanisms to manage investor expectations while balancing the costs associated with these strategies.
Polling results indicated that liquidity constraints may hinder timely exits, affecting investor satisfaction. This underscores the importance of developing clear liquidity management strategies that align with investor needs. Additionally, in poor market conditions, if an exit is necessary, the investment may need to be held longer to realize its full value potential.
Key success criteria for semi-liquid funds
As a result, the following key points that are critical to successfully navigate the challenges associated with the topics discussed during the roundtable can be mentioned.
1. Valuation framework
A clear and transparent valuation framework that includes, among others, availability of proper data in a timely manner, backtesting, consistent application of valuation methods and efficient communication with all stakeholders is essential for building trust with investors.
2. Liquidity management
A well-defined liquidity management framework is critical for addressing the complexities of semi-liquid structures. This may involve implementing lock-up periods and conducting liquidity stress testing as essential tools to navigate the complexities of illiquid investments and manage investor expectations. Also, qualitative analysis should not be disregarded as part of liquidity management.
3. Governance and investor reporting
Implementing strong governance practices ensures that valuation functions are aligned with industry best practices and regulatory requirements. The implementation of a risk-based approach to monitoring assets, based on their complexity and materiality, is essential for ensuring compliance and effective risk management. Moreover, following recommendations from the regulator, interaction with depositories has become more formalized for asset managers. As a result, depositories are more involved in review and approval of valuation related processes.
In conclusion, the roundtable hosted by EY Parthenon Luxembourg has illuminated the complexities and nuances of valuation oversight within the alternative asset management industry. The insights shared by industry experts not only highlight the pressing need for enhanced valuation practices but also underscore the importance of balancing investor demands with the associated costs and risks. As the industry continues to evolve, it is imperative for stakeholders to remain agile and informed, adapting to emerging trends and best practices. By fostering open dialogue and collaboration, the alternative asset management sector can navigate the challenges ahead, ensuring robust valuation frameworks that ultimately benefit both investors and the broader financial ecosystem. The discussions from this gathering serve as a vital roadmap for the future, guiding the industry toward greater transparency and accountability in valuation oversight.
Summary
The unique challenges for AIFMs in the context of semi-liquid funds were in the focus of our discussion at the recent roundtable organized by EY Parthenon Luxembourg.