Scarred by the events of the past year, these external stakeholders will not forget quickly or easily. One area where this is already being seen is in the valuation of private assets held by the large investment funds. Assurances of returns in years to come no longer hold water — and the pressure is on for the funds to show what’s really going as Mark Collard of KPMG’s Advisory practice explains.

 

In April, a draft European Union directive was issued, relating to the conduct of investment funds — by which we mean everything from private equity and venture capital funds right through to turnaround or real estate funds.

 

Amongst other things, the directive proposed far more stringent reporting on the value of private assets held by those funds; requiring annual reports and the involvement of an independent valuator.

 

At first glance, such suggestions might not seem that big a deal but I feel this is indicative of a distinct shift in terms of the attitude towards funds’ investments. In happier economic times, investors seemed more than happy to simply place their money into a fund for the requisite number of years, happy with the projected exit value of their investment and their fund’s ability to deliver a healthy profit.

 

Questions about the interim value of those investments were rarely raised. All that mattered was the exit value and it was taken for granted that such a value would be reached. Now, those more searching questions are being asked — by investors and shareholders but also by auditors and audit committees. No longer are they prepared to take everything on trust.

Such a shift in thinking may appear eminently sensible but the real interest in this issue is in how the funds will react — and how exactly they can be expected to provide accurate, realistic valuations in a time when attributing a value to an asset has never been more difficult.

 

Let us not forget that the EU directive is still in draft format only but, if it were to come to fruition, I believe that funds would be split in terms of their reaction to it. On one side, there are the funds that see it as best practice and also believe they can use their adherence to such guidelines to better market themselves to potential investors. In addition, it may be seen as helping them to head off any awkward questions which their auditors may have about their asset values.

 

On the other side are those who will see this as an unnecessary burden, suggesting that the exit value is all that matters. That may well be the case — but this is an issue of our times, when transparency matters above all.

 

Even the nay-sayers will have little choice but to submit to this though. Certain AsPac financial centers have long been a home for many fund administrators but relocating to such locations now to avoid the burden will look like an admission of having something to hide.

 

The reaction of the U.S. will be interesting in all this. Currently, many people involved in the funds industry in the U.S. would say that the new FAS 157 accounting rules which govern the reporting of these assets are fit for purpose. Certainly, from my own experience, these rules came into force at a time that coincided with the pressure building from external stakeholder groups. It is probably too early to see whether the practical application of FAS 157 will match external stakeholders’ expectations, particularly when there is lobbying from the U.S. fund industry for the authorities to dilute the application of the rules due to the difficulty in valuing private investments at the moment.

 

Now that the EU directive has entered the fray, if it is passed and is seen to be successful, it will be interesting to see whether that directive becomes a template for change in the global funds industry.

 

The part of the directive which some funds really might take issue with is over the compulsory appointment of an independent valuator. Some may argue that the fund administrators who currently fulfill that role are already sufficiently independent. Others claim there must be a conflict of interests inherent in such an arrangement.

 

However that particular issue resolves itself, whether the person in the firing line is the administrator or an external valuator, what is beyond doubt is that this is no time for amateurs. I have never known a more difficult time in which to conduct a valuation process. The metrics typically used in valuations must be applied with far, far more caution than in the past. In addition, there are far more judgment calls required in every single valuation than I can ever remember.

 

Currently, in our sphere of operations, it feels like everybody is watching us — and rightly so. Transparency is our new watchword and if we fail to deliver the required transparency to investors and shareholders, then we are doing the funds industry a grave disservice.

 

Mark Collard is a Valuations associate partner with KPMG in the U.K.