Valuations are next under the microscope

Private debt has been coming under closer scrutiny in numerous respects. The methodology used to value investments is likely to be the next preoccupation for investors.

Last week in this column we examined the progress made by private debt firms so far in relation to sustainability-linked loans, a topic which will be covered in depth by our February 2022 issue cover story. What we found, in our initial research, is that plenty of progress has been made but much more remains to be done.

This acts as a reminder of private debt’s relative immaturity as an asset class. Because it has come so far so fast in terms of investor allocations – as confirmed each passing year by our Global Investor 30 and Private Debt Investor 100 rankings – it’s easy to forget that private debt is a relative newcomer when measured against other alternative asset classes such as private equity and real estate.

In a press release, the European Leveraged Finance Association and Houlihan Lokey remind us that the European private debt market has grown from €8 billion in size in 2012 to €120 billion in less than a decade. With this rapid growth has come increased regulatory scrutiny, the latest example being the EU’s much-publicised pondering of whether private debt may pose systemic risk (the Alternative Credit Council’s response to this can be found here).

But it’s not just regulators keeping a close eye on the way private debt firms conduct themselves, it’s also investors. The credibility of sustainability-linked loans, as mentioned above, is one hot topic that they’ve been closely engaged with. The next one, and what prompted the ELFA/Houlihan Lokey press release, is the issue of how managers value their investments. You could argue that this should always have been front of mind, but while valuation has been the subject of countless private equity seminars and conference panels over the years, it seems to have been somewhat below-the-radar in a private debt context.

This looks set to change, not least because of the market volatility that was triggered by the initial pandemic outbreak in the early months of 2020. With dislocation funds springing up left, right and centre to take advantage of discounted loans, it was a challenge to anyone who had previously assumed that the value of loans would necessarily remain steadier and more predictable than ‘racier’ types of investment.

We don’t have room here to go into the details of how private debt approaches to valuation differ (ELFA/Houlihan Lokey have delved into it, and their findings are well worth a read here). Suffice to say differences exist, especially between managers based in North America and those based in Europe. There are also some signs that managers may be moving closer to a more blended approach. As with much of the other work it does, ELFA will no doubt be striving to bring best practice and consistent standards to this area in the months and years ahead as private debt continues its march to maturity.

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