The view inside Macquarie is that the entire issue has been overblown. While Macquarie did reassure investors on the Byju investment in May and October last year, the vehicle that holds the stake charges fees annually and retrospectively each April. So when the Byju stake is appropriately written down next month to reflect the drama around the company, the fees charged to Julius Baer and all other investors for the previous year will reflect the new valuation.
That may well placate Julius Baer and its investors in this instance, although it will be fascinating to see whether there are ongoing tensions here, given how public this spat has become.
But more broadly, the entire episode raises big questions about the way privately held assets are valued and the potential risks that could build up – both for individual managers and investors, and the broader financial system – if those valuations are not as accurate as they should be.
What’s particularly interesting in this case is that a fight has broken out between an investor and fund manager over apparent lag in valuation being written down. Typically, both managers and investors have an incentive for holding the valuation of a private asset higher, even if external events (such as company-specific problems, or a fall in public market valuations) suggest it should be marked down.
For the fund manager, the primary incentive in holding private asset values higher than they should be is more fees. For the investor too, the speed (or rather, the lag) with which private asset values are marked down is generally seen as a feature, not a bug. Yes, it obviously makes the return from that investment look better for longer. But just as importantly, it makes private assets (and the investors’ overall portfolio) appear to have much lower volatility than comparable public market investments.
No less an icon than the late, great Charlie Munger told the Berkshire Hathaway annual meeting in 2019 that it has appeared that many pension funds have loaded up on private assets specifically “because they don’t have to mark it down as much as they should in the middle of the panics. I think that’s a silly reason to buy something.”
Australian superannuation managers would likely argue that’s unfair, and point to the strong performance of private assets over the past decade as their main motivation for investing in the unlisted space.
But from Chanticleer’s soundings of the super sector, it is generally accepted that private assets do allow for a longer-term approach to investing than public markets. The argument goes that Wall Street or the public markets can and do overshoot, but a 20 per cent fall in sharemarket-listed education stocks does not necessarily mean the intrinsic value of a particular private education company has suddenly fallen by 20 per cent.
Valuation is not easy
And so the general approach by a private equity or venture capital firm, and their investors, is to hold the valuation for a period – a quarter, six months, or a year in the case of Macquarie’s annual adjustment to Byju – and then reassess.
But of course, we don’t let equities managers claim a stock it is still with X when the market has dropped and it is suddenly trading at Y. They can bleat all they like about the long term, but no one listens.
Valuing assets to reflect public market movements isn’t easy, but it’s not impossible. As Asness says, “perfect estimates are not the point, and shouldn’t be the enemy of good estimates”. So why do we let private asset managers, in his words, play make-believe?
The answer is that generally it’s not in the interests of the manager and their investor to quickly mark private assets to public valuations.
Clearly, the anger Julius Baer has towards Macquarie over Byju says there is a limit to this; when an asset’s value has so clearly deteriorated, no investor wants to pay fees on that.
But the bigger challenge for markets is that by treating private assets so differently to public ones, we risk creating a series of problems.
In Australia, where super funds are required to provide daily prices as members enter and exit a fund, the issue of inaccurate valuations (either too high or too low) disadvantaging members has been well canvassed, and the prudential regulator is pushing funds to improve their valuation approaches to unlisted assets.
But there are fears that poor valuation practices could create a more systemic stability risk. In a speech last month, the Bank of England’s director of financial stability, strategy and risk, Lee Foulger, said the global private credit market, which has grown four-fold since 2015 to about $US1.8 trillion ($2.8 trillion), expressed concern the potential risks in this market are being underplayed because most private credit managers are holding valuations higher than public market comparisons.
A recent Bloomberg investigation of the market showed debt in one company was being marked at a 35 per cent premium to where it was trading on public markets. In another instance, the same debt for the same company was valued at between 49¢ and 85¢ on the dollar by different private credit players.
Foulger said dispersion between public and private markets could leave investors over-allocated to private markets. But he sees a bigger potential problem.
“As interest rates have risen, so has the riskiness of borrowers,” Foulger said. “Lagged or opaque valuations could increase the chance of an abrupt reassessment of risks or to sharp and correlated falls in value, particularly if further shocks materialise.”
Foulger also noted the “significant interlinkages between private credit markets, leveraged lending, and private equity activity make them vulnerable to correlated stresses” and also raised the opaque nature of the private credit market as another concern. “There are significant challenges with obtaining reliable data to monitor the risks in private credit markets.”
The rise and rise of private markets has been one of the great themes of the past decade. But the spat between Macquarie and Julius Baer underscores what could be described as a lack of maturity in this sector. There is still no standard way of approaching valuations, no standard (or even broadly accepted) way of charging fees, no standard way to monitor the interlinkages and risks that worry Foulger.
