Private equity in open ended funds, can’t avoid the law of gravity

Here is an important article  published in the FT that questions the validity of the valuations of private equity , especially as it impacts the pensions we get.

A credibility problem for pension schemes

The FT team who wrote the (excellent) article , would  have been  interested spectators at the CISI talk given by Con Keating and Iain Clacher on Wednesday afternoon. They’d have been alerted to this important snip from the lates ONS publication of pension data

What it tells us is that while every other asset class was falling like a stone, private equity , valued in March 2022  at £81bn , was valued at £81bn a year later. Private Equity defied the universal law of gravitation.

The ONS derive these valuations from what pension schemes tell them they own, Pension schemes report the valuations they are given by their asset managers. 562 of the 5260 schemes are asked by the ONS to report. They include all the big DB plans.

Of course, these plans might have purchased private equity during the year, but this looks unlikely. The opposite is more likely. There is plenty of anecdotal evidence that pension schemes sold assets to meet LDI collateral calls.

I agree that  the numbers reported to the ONS aren’t credible (Keating and Clacher’s point). . How could they defy the gravity of the markets in 2022?

The ONS numbers reinforce the suspicions of the FT team who have questioned whether “fair value” is being given to the holdings of private equity stated by DB and DC workplace pensions.

Typically, private equity firms will use the valuations of comparable public companies as a guide for audits and investors. How accurate these are will only be determined when the asset is sold.

But with both the value of debt and equity of publicly listed companies falling over the period, what made private equity different?

This matters because the Government wants pension schemes to be net purchasers of private equity, and particularly of the hardest to value “venture capital”. The Treasury wants pension schemes to use private equity to provide savers with value for their money and to grow the UK economy. If pension schemes are buying assets at the wrong price, it is likely that the price will work against the interests of DC members and the interest of those sponsoring DB schemes.

The problem that the FT has identified is that valuations of assets are often conducted by less than independent valuers. This has been a problem in Australia for some time and has been addressed by Government intervention. It looks like similar intervention is on the way in the UK and the work of the FT , of Keating and Clacher and of the academics at Said Business School and Edhec, are critical to our understanding what makes for good in opaque markets.

In valuations of illiquid assets such as infrastructure, it is vital that full disclosure is made of changes to future cashflows. Thames Water is cited as an example of a stock whose value has plummeted though in private hands, not least because information on cashflows was not available to the market till the company had nearly run out of money.

The most notorious case of non-disclosed falls in private valuation is of course Woodford, but the recent gating of several large open ended property funds tells us that household names are not immune from the problems Woodford’s investors suffered.

Max Nimmon of Numis tells the FT

“After several fund gatings in recent years, confidence in the open-ended vehicles has continued to dwindle. We are surprised it has taken this long for the market to accept this.”

The public need to feel confident that what they are buying into – is value for their money. That requires as much transparency as the market can offer.

In my view – the open ended fund is not providing pension with the transparency that trustees and members need. The upcoming FCA review of pricing is therefore very welcome

Investment Trusts – a more transparent way to value assets

The use of unit trusts, LTAFs and other open ended funds creates two problems, the first is that the valuation of the underlying assets may be based on opinion rather than market forces, the second is technical, relating to the disclosure of costs.

The comparator is the investment trust, which is currently a greatly unloved and in my opinion – greatly undervalued – investment vehicle.

That vehicle is the listed investment trust which allows anyone to buy illiquid assets on the open market through a recognised stock exchange. The shares of an investment trust are marked to the market according to the standard laws of supply and demand.

To quote the FTarticle

Valuation gaps are most apparent in listed private equity trusts, which trade on stock exchanges and should trade close to the value of their assets.

UK private equity trust net asset values are currently about 30 per cent above share price valuations, data from the Association of Investment Companies shows.

That gap is close to a historic high, suggesting that share prices are cheap or asset valuations far in excess of what could be achieved in a sale tomorrow

To my mind,  many asset valuations are too high and the shares of the underlying assets too cheap. If the market is serving as a weighing machine, then it is suggesting there is an a lack of balance.

Problems compounded by unequal disclosures

The shares of investment trusts investing in private equity are currently discounted as the AITC report, but this is not exclusively down to valuation differences. There is also a problem for closed ended investment trusts in how they are required to disclose costs relative to open ended funds.

Excuse the technical language, but this is  how the problem has been explained to me

Under PRIIPS trusts have put the full costs of running the fund including the underlying investments in the KID; and then under consumer duty rules, many of the platforms are being told that the trusts have to be ‘de platformed’ as being too expensive.

The cost disclosure for unit trusts and LTAFs make them appear cheaper, so they are being promoted over investment trusts. This has the impact of depressing investment trust share prices further.

I’m told that the Treasury is aware of the issue (and presumably the FCA will know of it too).

The FCA is in the process of examining the way valuations of private equity are being managed and the competition issues that arise from differing disclosure rules.

These issues should be at the top of the Treasury’s “to do ” list. So long as doubt remains about the integrity of private market valuations and questions persist on the consistency of regulatory disclosures, trustees and the public will remain suspicious of illiquids, hampering the progress of the Mansion House reforms, depriving savers of better returns and the UK economy of much needed long-term capital.





About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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2 Responses to Private equity in open ended funds, can’t avoid the law of gravity

  1. conkeating says:

    I would recommend reading EDHEC’s full submission to the DWP’s call for evidence on options for DB schemes which closed in early September.
    A few quotations will illustrate why:

    “Thames Water: far from a unique case of risks that are poorly perceived by investors

    These practices must also be put into a market context: for a relatively long period of time, with falling interest rates and high demand i.e., a falling risk premium, the fair market value of unlisted infrastructure asset increased steadily. Keeping assets undervalued for the entire holding period enables managers to show a surprise “bump” in the valuation on exit and to secure their carry, while highlighting their purported ability to select the best assets.

    In a different rate environment, these incentives are reversed, and many private assets are now overvalued, as confirmed by recent industry surveys (Preqin Investor Outlook1), but it remains the case that reported private asset values are not representative of market prices and that these practices render any attempt at risk management impossible for investors.”


    ” For instance, the decisions made by the UK University Superannuation Scheme
    (USS) to invest in Thames Water, the London water utility, suggest that the plan was unaware of the level of risk and of the true value of the company. Over the past several years, USS invested several times in the famed utility, each time at higher reported valuations. In March 2022, it increased its stake and also reported a higher value for its existing investment, aligning the appraisal of its c.20% stake with that of OMERS, the majority shareholder, a Canadian DB pension plan.

    However, in December 2022, OMERS suddenly marked down the value of this
    investment by 28% (Financial Times, July 2023). In effect, the company is crippled with multiple layers of debt and faces rising costs including debt servicing costs that indexed on inflation. USS now has to recognise the same loss. Many stakeholders seemed surprised by the size of this loss in value.
    After all, it seems unlikely that a large water utility could lose almost one third of its value in less than nine months… However, this is not what happened.

    The owners of Thames Water recognised a large loss in December 2022 when in fact the company had been getting riskier and losing value for a decade! (a forthcoming publication by mBlanc-Brude & Whitaker develops this case in more details).”

    This referenced forthcoming paper appears not to have been published as yet

  2. Pingback: Investing in illiquids requires perfect information | AgeWage: Making your money work as hard as you do

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