Even Managers Are Worried About Valuation

At Milken, mark-to-market is still the topic du jour.

Illustration by II

Illustration by II

The private equity valuation debate’s stranglehold on the conference circuit isn’t letting up.

At the Milken Institute Global Conference on Monday, at least one investor spelled out the consequences of a private equity manager marking their assets higher than they are worth. They’ll walk.

“We’re seeing realizations come in lower than the marks,” said Molly Murphy, chief investment officer at the Orange County Employees Retirement System. “It won’t happen instantaneously, but end investors will lose confidence in people who are not being intellectually honest.”

This was her response to a broader set of questions posed to a panel by John Bowman, executive vice president of CAIA Association, on the role of both investors and general partners in the valuation process.

“When I first started investing in private equity, you had a very tight band that was very symmetrical,” Murphy said. When public markets would go up, private markets would follow, but in a slower, more tempered way. The same was true in downturns.

However, Murphy noted, in the past five or six years, she’s found that both investors and PE firms don’t want to see their portfolios marked to market on the way down.

According to Bennett Goodman, executive chairman at Hunter Point Capital, this isn’t necessarily a bad thing.

If managers don’t revalue assets every quarter, “my judgment is that it is not terribly consequential,” Goodman said. “That doesn’t mean that there aren’t abuses or that there shouldn’t be a more standard methodology on how private managers mark.”

Eventually, however, investments are sold. Jeff Aronson, co-founder and managing principal of Centerbridge Partners, said the ultimate sale price will show limited partners exactly how their manager has been handling valuations.

“Ultimately the truth is going to be told,” Aronson said. “There’s going to be some type of realization.” He added that limited partners will vote with their dollars, moving to other managers that mark assets more appropriately.

Andrew Milgram, CIO of Marblegate Asset Management, pointed to the gap between liquid credit and stock markets, noting that the high yield index and S&P 500 were both down, even as private credit indices were up over the past year. “That just feels like allocators are being asked to swallow something that is off,” he said.

While he agreed with Aronson that private markets managers that overvalue assets will eventually face consequences, he noted that their actions have a greater effect in the near term than they may think. To his point, allocators and others use current valuations to make buy and sell decisions about their broader portfolios.

“I think it’s hard to go to a broader community of participants until we provide that transparency,” Milgram said, referencing the desire of some asset managers to offer investments to retail investors.

Allocators, at least, have more transparency than many believe, Murphy pointed out. Two private equity firms in the pension’s portfolio may own the same asset, or they may trade it between themselves. OCERS is able to see where those valuations change, and asks questions based on that, especially when one private equity firm buys an asset from another.

“We need them to rationalize that value because otherwise, all I’m getting is transaction fees,” Murphy said.