I was listening to my friend Chris Sier on Friday talking about how the transparency agenda has moved on. Chris was talking about how asset valuations are arrived at in private markets, particularly as regards “private equity” where there is little clarity about what is being bought and where the prices is often determined by the seller with little push back from the market. To put it simply, it’s you against the private equity manager and unless you are a professional purchaser, it’s the private equity manager who has the upper hand.

The valuation process and its shortcomings has been scrutinised by Ludovic Phallipou and Chris was referring to his research. The asymmetry of information between seller and purchaser has been exploited by both the asset and fund management businesses, so that the primary business of many in private equity is not the creation of value for long-term asset owners but the extraction of value by financiers.

If there is to be a “Compact” between pension schemes, their fiduciaries and their owners on the one side and the managers of private market investment on the other, it needs to focus on “fair value”. This is the thrust of Sier’s and Phallipou’s argument. The private companies that thrive in the UK and overseas , do so because they are well managed and therefore deliver value despite their being less regulated. Those that fail, typically are less than transparent.

An example of a failure in private markets emerged at the end of last week , when what had been touted as a £500m inward investment into the private equity of Thames Water , was revealed as a “convertible bond” , paying the bearer 8% which would only become an equity investment if certain hurdles had been hurdled. It’s mutton dressed as lamb as far as the beneficial owners of Thames Water are concerned. One of the largest owners of Thames Water is USS – its members should be concerned, not just about the increase of debt, but that it was introduced with subterfuge. Any compact , must formalise that “governance” is at the heart of good investment – and the endpoint of E-S -G.

So how can we improve the valuation process to give savers a better chance of winning from private equity rather than being rooked. Well, I ‘d start by examining the structures which are being used to deliver this “fair value”.  One the one hand we are asked to consider the “fund” – in particular the Long Term Asset Fund or LTAF.

The idea here is that private assets can be packaged and marketed to savers on fund platforms – either with an insurance wrapper (using insurance platforms like Mobius LGIM and Phoenix) or we can buy the package within and investment company ” listed on a public market – an investment trust or to a limited extend a venture capital trust.  A third alternative is to buy private shares directly – which the retail investor can do through platforms such as Seedrs, typically as “crowd-funding”.

At the other extreme, very large purchasers , such as the Australian Supers, the large Canadian pension funds and some UK occupational schemes (USS being one) can buy the equity of companies like Thames Water from those willing to sell (typically private equity managers but sometimes the founders of the organisations). It should be noted that some large companies such as Mars are still owned by their founders.

I am not excepting funds as an acceptable structure. But a fund looks a very untransparent vehicle by comparison with a listed investment – or one where there is a recognised secondary market. This is primarily down to such markets determining the price of the asset , both in times of the capitalisation of the company and the share price.

The price may not always reflect “fair value”, (the recent discussions on the cost disclosures surrounding investment trusts being an example of regulatory distortion of the sales process) but the price is what others are prepared to pay for what you own. That price should reflect all the costs associated with managing the assets of the (investment) company (why Mifid disclosures effectively disclose the price twice).  But the likes of the AITC and the lobbying of independent experts such as Ros Altmann and Sharon Bowles, corrects such anomalies. I was pleased to see the Autumn Statement addressing this issue.

I am not so confident that there is a mechanism to protect savers against fundamental over-charging or accidental mis-pricing. What a fund does, is create an intermediary layer between the investor and the investment which can be manipulated by the fund managers to make sure that they – rather than the saver – is protected. We see this in the “gating” mechanism, where the fund is protected from disinvestment by a gate being slammed on investors getting out. Investment companies do not “gate”, investors are less protected from runs on the fund but – assuming they have done due diligence – they are not looking to sell on short-term market factors. Again, the ideas of a Compact between investor and the the investment should hold good.

A second worry I have about funds, is the concentration of ownership within the fund itself. I have learned this weekend that 2/3 of the assets under management within Somerset,  were managed on behalf of SJP. When SJP withdrew their support, the future of the fund manager was put in doubt. Those in Somerset funds may well be pressing the panic button (I hope they don’t), the fund may be gated and the interests of the remaining fund holders jeopardised.

To suppose that the ownership issues surrounding private assets is down to “fund charges” or to valuation techniques, is to put the cart before the horse. What is needed is a Compact between investor and the investment to ensure “fair value”. Transparency of charging and consistency of valuation is part of this, but it is the “cart”. The “horse” – the thing we rely on to get us to our destination , is “good governance “. No amount of regulating the cart can ensure good governance, but a true Compact that aligns interests fairly – can.