414 Capital Director Ariel Fischman explains the growth of third-party valuation in alternative assets and why GPs should consider them
414 Capital Director Ariel Fischman explains the growth of third-party valuation in alternative assets and why GPs should consider them
The Global Financial Crisis (GFC) taught us that failure to fully understand the value of underlying assets can have significant global consequences for investors, shareholders, and the public. In the decade-plus since, regulators have increased their scrutiny of the valuation profession and taken practical steps to increase transparency to mend what they view as a history of inconsistencies. In the case of the US, the Securities Exchange Commission launched the Financial Reporting and Audit Task Force to identify financial reporting and auditing violations.
As the alternative assets industry has grown, its outperformance has resulted in ever more sophisticated investors who are naturally demanding greater transparency and valuation governance.
The demand for greater transparency begins with asset valuations. Many alternative investment managers have historically valued investments internally, a process ripe for conflicts of interest and full of potential for upward biases. As such, the industry is increasingly moving away from these self-assessments.
Achieving true independence or a complete separation of duties can be challenging for many firms. This practice can be easily perceived as biased and bring valuation objectivity into question. In Europe, for example, the Alternative Investment Fund Managers Directive (AIFMD) has established a valuation framework – Article 19 – for EU-based alternative investment managers and funds to attempt to remove this conflict of interest. The article establishes that the internal valuation function must be independent from portfolio management, which can be an important issue for firms since the portfolio management function can provide most of the information required as inputs into the valuation process.
In regions where there’s no such requirement, investment managers have two primary options to advocate for greater transparency: create an independent internal valuation function, or delegate all valuation responsibilities to an independent third-party valuer.
In the case of an internal but independent valuation, this process requires some level of subjectivity, which can produce biased results and still require a third-party opinion. Indeed, third-party valuation providers are becoming essential to aligning managers’ interests with those of their investors, both current and potential – particularly with regards to fundraising, performance reporting, and financial reporting compliance requirements.
For many managers, choosing a third-party independent valuation provider isn’t an easy task. Operationally, investment managers need to verify complete independence and freedom of conflict and avoid any direct or indirect affiliation with the provider, typically found with larger asset managers or banks. This allows complete freedom to adhere to standard methodologies with flexibility of judgment. In the case of 414 Capital, the firm has strict internal controls and compliance policies in place, which are shared with complete transparency to clients to manage any possible conflict of interest among the firm’s business divisions and protect valuable information.
Among other key considerations, investment managers need to consider a provider’s experience in specific asset classes with a proven track record and evaluate their methodologies and adherence to industry standards and best practices. To this effort, what are the core methodologies used to derive the valuations? Which data sources are used in models or statistical analyses? And which assumptions are used in the valuation exercise? As, such, investment managers should look to independent valuation providers with the capabilities and experience needed to provide these valuation services.
With alternatives AUM predicted to rise exponentially into 2025, according to Preqin data, demand from allocators for more transparency and improved financial reporting adherent to uniform standards will also increase. Transparent, unbiased, and accurate valuations are drivers for best practices, proper allocation of capital, and optimized functioning of a market economy.
About Ariel Fischman
Ariel Fischman, founder of 414 Capital, began his career in the financial industry in 2001, working for international financial institutions including Goldman Sachs, J.P. Morgan, and BankBoston, both in Mexico and in the US. He has served on the board of several private and public companies.
About 414 Capital
414 Capital is a corporate finance house with presence in the USA and the Americas. 414 Capital set itself apart by having a dedicated valuation practice with experience across all asset classes which offers a suite of services ranging from portfolio valuation and fund advisory to financial reporting and tax planning and compliance.
The firm’s valuation group is deeply rooted in its portfolio valuation and their fund advisory practice has performed over 15,000 valuations for over 100 funds across all asset classes in nine countries. In March 2021, Harvard Business School selected 414 Capital for its Case Study Collections for the firm’s complex valuation capabilities in the real assets sector.