Our Data, Ourselves
How accurate is pension performance reporting? As pensions increasingly turn to illiquid investments to meet their return goals, new questions arise about whether quarterly or in some cases daily performance numbers accurately reflect the true valuation of a portfolio and its potential return.
Fully audited valuations and performance reports can take anywhere from a quarter to one year to flow through to asset owners depending on what is being audited. That can lead to a significant disparity between asset values and portfolio reporting. While it doesn’t mean anything nefarious is happening, it does mean that from a governance perspective, the numbers that are being reported should be viewed with a critical eye.
Asset managers are often quick to point out that the benefit of illiquid asset classes is the smoothing that can take place over the lifecycle of an investment. One bad year in a 10-year investment can be mitigated over time, they say. But it’s hard to determine whether that holds in high-inflation, high-volatility markets where private assets have already had notable write-downs.
There is also the question of how valuations are provided. Many sovereign wealth funds and pension funds outside the U.S. have internal investment and valuation teams, which can serve as a check on the data provided by asset managers. But that’s not a strictly independent process and if these internal teams are doing their own deals, accepting those valuations at face value is somewhat fraught.
Many US pensions lean on the valuations provided by a combination of asset managers and consultants, which may show a directional return but is hardly objective or independent. A new roadmap could be emerging, however. Regulators in Australia are pushing for more transparent and timely valuations. There is also a new emphasis from LPs worldwide on data gathering that could lead to better visibility into otherwise opaque asset classes.
Supers Under the Microscope
One example of the recent volatility in private assets is technology company Canva. Canva was a success story of Australian private equity. In 2021, the company was valued at $40 billion, garnering investments from well-known asset managers and pensions alike. Some Australian superannuation funds became significant stakeholders in the company. Then, in August, investors slashed approximately $20 billion off its valuation.
In recent weeks, the Australian Prudential Regulation Authority has sent a letter to a handful of superfunds asking questions about their exposure to Canva and how they are valuing private markets investments in general. Canva’s write-down came after the June 30 end to the fiscal year for many pension funds—not just in Australia. To the extent that pension funds had exposure to just this one company, the figures from June 30 aren’t likely to be fully reflective of the actual value of all assets in the portfolio.
This letter comes on the heels of a new regulatory effort from APRA announced in July pushing superfunds to improve transparency, gather more data, and rely more on independent valuations. At the beginning of October, APRA also released an additional thematic review of service providers with best practice guidance for supers to ensure they aren’t overpaying for services and are on the lookout for conflicts of interest.
Superfunds have a different structure from many pension funds in that they have to offer a daily value because participants can decide to switch funds on a self-directed basis. Participants may be able to arbitrage an investment premium if valuations lag or are otherwise inaccurate fund to fund. This places unique pressure on superfund managers to get more information about the slow-to-mark assets in their portfolios.
Ashby Monk, executive director of Stanford’s Long-Term Investing Research Initiative, says the work superfunds are doing could be a helpful case study to allocators in terms of how to build more objective valuation models. “Australian superfunds have invested quite a bit in their models to be able to strike a daily NAV,” he explains. “The regulator is also requiring more information about fees and the total cost of these investments. I think that’s probably a good thing. Australia is really becoming an innovator among allocator-rich countries.”
Staying Ahead of the Curve
What’s going on with superfunds highlights two core issues with valuations in general—time horizon and valuation modeling. Even if an allocator doesn’t have to offer a daily NAV, when valuations are created is almost as meaningful as financial performance.
Will Goodwin, head of direct investment at New Zealand Superannuation Fund says that it’s important to keep reviewing when valuations are getting done to make sure they are reflective of current market conditions and are in line with regulatory requirements.
“We don’t have members coming in and out of the fund the way that they do in Australia,” Goodwin says. “We do our valuations annually. But we are doing testing and review to determine whether we should do them more frequently and what that would look like. If you look at the Canadian model, for example, they have an in-house team doing nothing but valuations and that’s a trend that you’re seeing more. It’s been a useful exercise for us to consider what the right timing is whether that’s quarterly, bi-annually, or annually. I think that’s the direction of travel for asset owners generally—to improve visibility. Regulators want to see that too.”
Charles Wu, CIO for Australia’s State Super agrees. “If you think of the example of COVID——we had the airport get shut down right away—that’s an extreme event,” he explains. “If you do not make valuation adjustments to reflect the potential impact of that, then it would have created an equities unfairness for people who were going to leave the fund in the summer of 2020. So, in that case, we had to make the call and adjust the valuation. At that point in time, we went from once a year to once a quarter. What we’re dealing with now is market volatility. It may not make sense to change the valuation frequency for volatility because it’s not an extreme shock event the way COVID was.”
Even if valuation timing doesn’t need to be changed in response to volatility, the valuations themselves may need to be adjusted to reflect changes in financial performance.
“You really have to start with the notion of what number is the best representation of future cash flows,” says Keith Ambachtsheer, co-founder of CEM Benchmarking and CEO of KPA Advisory Services. “If you say ‘markets know best,’ there is a counterpoint to that, which is to say markets are really not that great on a day-to-day basis at valuing present and future cash flows because they are reactive. This impacts private assets as well because there is a tendency to lean on bias. If you create an independent rules-based valuation framework that is transparent, you’re probably going to get a better idea of what an appropriate valuation is regardless of what markets are doing.”
Ambachtsheer argues that there is a need for more research on valuations and that allocators should look more critically at the information they are getting. “If someone has a formula, you have to ask ‘ok what is the methodology here? How are you getting there?’ And get outside opinions,” he says.
Wu adds that it’s important to consider historical and systemic bias as well. “Asset owners have to keep their eyes open in this environment and this applies across asset classes. Most market participants right now have never witnessed high inflation periods or the scale and magnitude of interest rate hikes that we’re seeing,” he explains. “So even if you say ‘we’re data dependent’ there are not going to be examples available in your sample data. So that changes how much you can lean on your working assumptions.”
NZ Super’s Goodwin agrees. “We’re running fire drills on our portfolios fairly regularly,” he says. “You want to keep a laser focus on liquidity and you never want to be in a position where you have to be a forced seller. During volatility that requires more stress testing of your analysis. It’s a much better position to have a good idea of the direction of where things are headed and be able to take advantage of opportunities.”
Never let a good crisis go to waste
Current market conditions could open the door to better governance. Monk notes that allocators are taking a closer look at the future of their portfolios, which could provide an opportunity to improve transparency.
“What’s difficult—especially in the public pension sphere—is that there is still a lot of underfunding in pension plans,” he says. “A lot of consultants and actuaries are saying the only path to meeting those goals is to continue to allocate to private markets so the demand side for those asset classes is going to continue to ramp up. It almost feels like the alternatives bucket is becoming the conventional bucket.”
In a world where that is true, there is greater potential for more Canvas to ding portfolios without proper risk management in place. But there are also more tools available today to gather investment and fund-level data and hold companies and asset managers accountable.
“I think anytime there is a crisis, there is an opportunity to look at pension governance and determine if we need to make some changes going forward,” Monk says. “With the tech crisis in the early 2000s, for example, we got liability-driven investing. After 2008, we started doing risk factor-based portfolio construction. So, then the question is what is the current crisis going to reveal? I think in part it is going to speak to a lack of technical sophistication. We need a much more granular understanding of portfolio data.”
Related Stories: