In the wake of the coronavirus crisis, LPs have a dilemma. Most public pensions are required to report the net asset value of their private equity fund interests on a quarterly basis. But to do that for the first quarter of 2020 amid the market chaos the pandemic has wreaked, LPs will need to work harder than they ever have.
“LPs have a difficult conundrum,” David Larsen, a managing director at Duff & Phelps, told Buyouts in an email. “They must adjust lagged net asset values for each fund if the underlying fair value of investments has significantly changed from the last reporting date to March 31, 2020. It is possible that the difference is not significant. It is more probable that the difference will be significant given the magnitude of the economic crisis.”
LPs will need to have the most accurate possible numbers on the fair value of their GPs’ investments and they will have to have them as early as possible.
When LPs report the quarterly values of their fund interests, they start with the last net asset value reported by their GPs and adjust for capital calls and distributions during the quarter.
Usually, the last NAV reported by their GP will be lagged three to six months. LPs do not usually adjust the underlying lagged fair value of investments if they deem the difference not to be significant. Accounting industry standards and guidance allow for this wiggle room.
“In times of normalcy…it’s not as big a deal that the limited partner or the investor is using data that is kind of in arrears, even though that’s technically not allowed,” Larsen said. “The caveat [is that] it’s not allowed except for if the difference is not significant.”
What constitutes a “significant” difference in the fair value of underlying investments, which is represented by the net asset value of a fund interest, is essentially a judgement call for LPs. But in the current environment, LPs will need more information to make an informed judgement.
Enhanced due diligence
Last week, Duff & Phelps hosted a webinar titled “Coronavirus: How should institutional investors be valuing fund interests at March 31, 2020?”
“This quarter is going to be one that is going to be requiring more diligence than perhaps you’ve had in previous quarters,” said Sumner Estes, director of portfolio valuation at Duff & Phelps, to the participants.
One of the solutions recommended in the webinar was for LPs to call each individual GP and get them to provide the most accurate fair value estimate possible of expected net asset value as of March 31. Around 64 percent of the participants agreed that institutional investors should be working with GPs “on a case-by-case basis” to achieve fair value-based NAVs, according to sister title Private Funds CFO.
“They’re going to be busy, but to the extent you can get input from them, then that’s certainly going to be helpful in your process,” Estes said at the webinar. “There’s certainly going to be more work involved on the LPs’ parts just making sure that they’re comfortable with the NAVs that they’re reporting.”
“The managers have to do as good a job as they can do in coming to fair value,” Larsen told Buyouts. “They have to do that as quickly as possible, and the limited partner investors need to take that information and say, ‘Hey, what am I going to do? How quickly do I need to report? How am I going to change my process?’ Because this is different than what they’ve experienced before.”
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