Downturns Can Throw Portfolios Out of Whack. Here’s How to Fix Them.

There is more than one right answer — and it all depends on how private assets are valued, according to PGIM.

Michael Nagle/Bloomberg

Michael Nagle/Bloomberg

How asset owners rebalance their portfolios depends on how they value private investments — and there’s more than one way to get it right.

According to a recent paper published by PGIM, massive market dislocations like the one that took place in March 2020 leave asset owners with a conundrum: if, and when, they should rebalance.

“When reported private equity valuations lag public market valuations during public market declines, CIOs often find their portfolios over-allocated to PE,” the paper said. But the lag in valuations may not represent the most updated private equity performance data, meaning that allocators could be rebalancing when they don’t have to.

PGIM explored two different ways to value private investments: proxy market value (PMV) and the Takahashi Alexander (TA) model. What PGIM found is that the decision to rebalance is affected significantly by the valuation method an allocator uses, and that the appropriate use for each depends on the type of institution using it.

According to PGIM, the proxy market valuation method may be used by allocators who are concerned that private equity firms overstate their quarterly valuations. This method uses quarterly public market performance to estimate how much net asset value has changed during the same time period.

PMV is responsive to public market performance, which can be attractive to groups whose plan participants are especially sensitive to the stock market. But, it doesn’t connect a valuation to cash flows, nor does it incorporate commitment history and strategy.


Enter the Takahashi Alexander model, which links cash flow and net asset value using the rate of growth over the investment’s lifespan. This method incorporates commitment history and strategy, which according to PGIM is a plus. But there are downsides. This model relies on estimates or simulations of public market performance.

To compare the two, PGIM simulated a V-shaped recovery similar to the one that began in March 2020. The baseline portfolio the firm used was simple: $20 in debt, $40 in public equity, and $40 in private equity net asset value. To simplify the calculations, PGIM assumed that the valuation of the debt hadn’t changed.

In the simulation, public equity fell to $28. Under the PMV method, the private equity valuation also fell to $28, while under the TA method, it stayed the same.

Using the PMV calculations, both the public and private equity allocations dropped from 40 percent to 37 percent, while the debt allocation rose to 26 percent. The TA calculations, meanwhile, resulted in private equity rising to 44 percent and public equity dropping to 35 percent. The debt allocation also rose to 22 percent.

This is important, because it changes how much an asset owner chooses to sell or buy to hit their target allocations.

For sovereign wealth fund managers, the TA method may make sense, because “they can ride out distressed market periods without attempting to ‘mark-to-market’ private equity,” according to PGIM. Defined contribution plans, meanwhile, may not be able to use the TA model because a public market downturn could trigger participant withdrawal requests.

“Irrespective of the private equity valuation approach, when the private equity allocation deviates from target, investors need to decide if they prefer immediately bringing private equity back to target or gradually rebalancing by adopting a rebalancing strategy that avoids active trading of private equity,” the paper said.

According to PGIM, allocators might consider rebalancing less frequently, implementing wider rebalancing bands, or grouping public and private equities together as “growth assets” to avoid having to do this too regularly.