Cedric Bucher, CFA, CEO Hearthstone Investments, writes that with the increasing popularity of private market assets, the proportion of such investments held by institutional investors can now make up a significant part of the overall portfolio allocation.
Typically, private markets include four sub-segments: private equity, private debt, infrastructure and real estate. Critically, unlike for public market assets, these assets are not listed or regularly traded in a secondary market. This means there is often not a timely, publicly available price as a basis for valuations.
So, how confident can investors be in the valuations quoted for these assets?
Unsurprisingly, their valuation is attracting increasing scrutiny from investors. In the UK, according to a recent FT report, the Financial Conduct Authority is preparing a review that “will examine ‘disciplines and governance’. This includes looking at who within a firm is accountable for valuations, how information about those valuations is passed upwards to the relevant management committee and board, and what other governance procedures are in place.”
How are valuations undertaken for residential property, possibly the oldest private market investment? And can investors rely on them?
First and foremost, valuations for these funds are generally outsourced to independent valuers. Whilst this might sound obvious, it is not always the case for private market investments, with some funds performing valuations in-house – effectively “marking their own homework”. For residential property, the governance framework also stipulates a transparent process for the selection and regular review of independent valuers, looking at their capabilities, qualifications, track record, process and pricing.
The independent valuers must be RICS accredited and must follow the RICS “Red Book” valuation standard, a global set of rules and guidelines to ensure consistency across the industry. Valuation frequency varies by fund type, but for institutional funds quarterly valuations are typical, with a desktop review of all assets supported by physical inspections once a year.
Data is key in deriving accurate valuations. Luckily, there is an abundance of data available for residential property valuers, with a high volume of transaction and rental evidence given the size of the market. As an example, across the UK in September 2023 alone, there were 92,600 residential property transaction. The market, and therefore the availability of reliable data, is particularly deep in housing schemes and low-rise apartment blocks diversified across the regions.
In terms of governance, there are two further important points to note. First, valuations are scrutinised by the appointed regulated fund manager, and often also reviewed by an independent investment committee. Second, once a year the fund’s independent auditor also assesses valuation governance and outcomes.
Finally, if, in extremis, valuers decide they cannot produce accurate valuations for certain assets, they can trigger a “material valuation uncertainty” clause. This can be used in circumstances when the normal operation of the market can no longer be relied upon. An example was the pandemic lockdown in the spring of 2020, when property viewings were not permitted, leading to a sharp but temporary drop in transaction and letting activity.
Institutional investors in residential property, arguably the most liquid of private market asset classes, can take comfort that stringent governance protocols are in place to ensure independent and timely property valuations are fed into their overall scheme valuations.
