The Takeaway: A Q&A With Milko Pavlov on Demand for Private Markets Valuations
What is driving demand for private markets valuations services?
How have LPs evolved their attitude toward private markets valuations?
The growth of alternative assets—and in particular, private credit replacing bank lending— has meant LPs are looking for enhanced transparency and reporting requirements from the funds they invest in. LPs, and more specifically, seed and anchor investors in private funds, are now more likely than ever to require third-party valuation as they are looking to make capital allocation decisions based on reliable reporting from asset managers and be more confident about the underlying NAV of the asset manager. Regulators are also taking a much deeper look at private market funds and their processes, given their growing share and importance to the financial system.
How have GPs reacted to that pressure?
In recent years, the fundraising landscape has become more competitive. Consequently, GPs seem willing to acquiesce to LPs’ demands to raise capital, and independent valuation is a key part of the due diligence request list. Most GPs are aware that in order to attract high-quality LPs, they need to conform to best practices and having an external valuation agent is one of the requirements.
What about regulators’ increased interest in private markets valuations?
In the past few years, regulators have made significant efforts to focus on alternative asset managers to identify potential problem areas, such as valuations, which stresses the importance of a robust valuation governance framework. Other aspects include fees, expenses, and guaranteeing the fair treatment of investors.
How does this market compare with other periods of dislocation over the past few decades?
It is very distinct. The current market is most like the one of the late 1980s and early 1990s, when there was a massive liquidity problem, the banks were not lending, and there was no notion that the Fed and the ECB would come to the rescue. Most professionals in private debt have never worked in an environment in which central banks are not solving problems via the easing of interest rates—that is a hugely significant difference. It has been an exceptionally long time since credit markets have had to sort things out on their own. The key item in this environment is to acquire assets that are appropriate for the fund structures you are managing. With this level of market volatility, the ideal scenario is to have structures with long-dated, locked-up capital. The key is not having to worry about where assets trade in the secondary markets during the current volatile environment.
How does the outlook for private debt in 2023 compare with other alternative asset classes?
All the structures in this asset class use floating rates, which in this environment of higher rates has a significant impact. In normal times, fund managers are happy if they can move a fund return by 0.1%. And yet, the backdrop over the past year for a 300 to 400 basis point rise in rates has created significant benefits as well as challenges. It is a massive tailwind for the private debt market— but of course, it is generating a significant headwind for private equity. Compared to private equity investors, private credit has some measure of security or preference in the capital structure and a floating rate that protects investors against any further rate rises.
Do you see any major differences between private credit markets in the U.S. and Europe?
European private debt transactions offer lenders greater protections in times of stress. European private debt issuance comprises first lien lending with strong protections. Most loans include covenants that limit a borrower’s ability to impact the value of a loan negatively. These include maintenance-based covenants and other lender protections, such as requiring borrowers to meet certain financial conditions, such as keeping their ratio of debt to EBITDA below a specific level. Over the past 12 months, 84% of European transactions were structured as a first lien.
Milko Pavlov
Managing Director