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Valuation: Finding the right balance between impartiality and expertise

Valuation: Finding the right balance between impartiality and expertise

EY Luxembourg’s latest Alternative Investment Funds (AIF) Club event gave occasion to conducting officers and valuation professionals to exchange on the current challenges of the everchanging sector.
Christophe Vandendorpe, Partner, Strategy and Transactions Leader et Roman Makienko, Manager, Strategy and Transactions
Christophe Vandendorpe, Partner, Strategy and Transactions Leader et Roman Makienko, Manager, Strategy and Transactions
Photo credit: Photo : EY
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Christophe Vandendorpe and Romain Makienko share an overview of what is currently shaking up the valuation oversight function.

After a halt in deal activity driven by the onset of the COVID-19 pandemic, alternative investments bounced back through 2021 and beyond. According to McKinsey & Company, private market assets under management grew to an all-time high of $9.8 billion in July 2021, an increase of 32% compared to the prior year.

While we await the release of complete investment data for 2021, some insights can already be drawn. High inflation and slowing economic growth are weighing on alternative investment activity and pricing. Eurozone inflation in May 2022 climbed to 8.1% and analysts predict that the European Central Bank could raise interest rates this year. The World Bank forecasts slowing global growth to 2.9% in 2022, compared to 5.7% in 2021, due to inflation and the Ukrainian conflict. Such developments will likely influence commercial real estate, infrastructure and leveraged buy-out values for years into the future.

Addressing and evaluating the most pressing issues of investors

Increased uncertainty associated with various unfolding macro events should give pause to officers responsible for the valuation function in the Alternative Investment Funds Management (AIFM) sector. Managers must ensure that their valuation function continues to meet investor requirements. In June 2022, the EY Luxembourg AIF Club organized a roundtable event on valuation oversight and the challenges it poses to AIFMs. The conducting officers and heads of valuation in attendance identified ‘valuation committee independence’ and ‘relevant expertise of valuation committee members’ as two of the most pressing issues they are facing today.

Portfolio managers have intimate knowledge of assets and recent market developments. As such, they cannot be considered fully impartial per the AIFMD regulations. However, non-conflicted valuation committee members, on the other hand, might lack specialized knowledge of the specific portfolio assets, valuation techniques and market dynamics. Recourse to specialized external appraisers may contribute to mitigate such inherent conflict.

What is more, as investors continue to demand ESG-compliant investment options, fund managers cannot afford to overlook this topic. Most of the roundtable participants agreed that ESG is still a new topic that is yet to be properly integrated into valuations. As of now, premiums associated with ESG characteristics of alternative assets are usually not reflected directly in valuations. However, some asset values may be discounted by the valuer if the asset is underperforming its peers in environmental considerations.

These issues are not ones that can be solved overnight and will likely continue to be top of mind for the industry going forward.

Finding the right balance

AIFMs must be mindful of the balance between expertise and impartiality of valuation committee members. Furthermore, as time passes, ESG criteria are bound to be integrated into the valuation process. AIFMs must be ready to adapt their valuation functions accordingly so as to not be left behind by their peers.

Christophe Vandendorpe, Partner, Strategy and Transactions Leader, comments: “AIFMs could mitigate these issues by closing the gaps in expertise through continuous upskilling via trainings and by creating new roles within the AIFM that would be filled by subject matter experts. Additionally, our multidisciplinary teams are available to augment the valuation oversight function through our valuation and ESG service offerings. From the full outsourcing of the valuation function through our managed services to ad-hoc expert consultation.”

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