There is clearly a massive amount of volatility in both the public and private markets right now. While information is readily available in the public markets, the volatility of private markets is also open to question, and not just because of COVID-19. Rightful attention to this pandemic is given in Part II of this series: Handling Public & Private Market Volatility: COVID-19. Multiple events during the past year, beyond just the virus, have led to increased institutional investors’ concerns that portfolio valuations may be subject to a greater-than-expected level of risk.
A growing array of institutional investors – including pension funds, endowments, foundations, OCIOs and family offices, among others – hold multi-asset class portfolios that contain allocations to equities, fixed income, private equity, hedge funds and other asset classes that entail both liquid and illiquid holdings, some with limited transparency, that are all prone to fluctuations in value. Such investors should be asking themselves: Do we have the tools to model and report the impact of sudden changes in valuation of investments as they occur?
Examples of Market Volatility Abound
One need only look at the past year’s market fluctuations to understand the level of volatility inherent in in the public markets. While the past two years have represented an overall bullish view with most indicators hitting their all-time peak around mid-February of 2020, it was no surprise to see a 3-5% fluctuation on any given day. For instance, the DJIA went up 4.98% on December 26, 2018, S&P up 4.26% on January 4, 2019, S&P dropped 3.79% on May 13, 2019 and DJIA dropped 3.05% on August 14, 2019. In short order, the public markets have experienced a plunge of 20-35% in a matter of weeks!
There is also plenty of evidence around the volatility of private investments. Long prior to the market developments related to COVID-19, WeWork is Exhibit A. Softbank’s recent capital infusion valued WeWork at about $8 billion – a far cry from the $47 billion estimated at the time of the company’s planned and subsequently aborted IPO.¹ However, WeWork is merely one example. Exhibit B: Vice Media, the youth-oriented digital media and broadcasting company, recently acquired the women’s lifestyle publisher Refinery29 for approximately $400 million, mostly in stock.² Vice Media was on pace for $600-$650 million in revenue in 2018. On this basis, the implied valuation for Vice Media on the low end would be around $3.6 billion. Yet, Disney, which owns 27% of Vice Media, wrote its investment down to $0, strongly signaling its belief that the company will neither go public nor be acquired for such a material valuation.³
It is no wonder, then, that several voices have raised concerns about investment volatility. Many portfolio management technology products that serve asset owners and allocators only produce monthly updates and are therefore not equipped to deal with fluctuations of this nature and timing. How can investment teams be expected to make the right decisions when they don’t have access to accurate, readily available information? A solution that provides comprehensive coverage across all investment types, including asset groupings, classes, funds, managers and individual securities held by the portfolio is the only path to success in today’s environment. An article by KKR’s Henry McVey and Frances Lim noted that the firm’s clients questioned the validity of risk-adjusted returns in private markets. Even if solved in isolation, it is still not possible to make informed decisions without the full, complete picture across the entire book.
In short, investors have good reason to ask about the growing volatility of investments. Unprecedented market volatility and a general lack of transparency and liquidity in the private sector creates vulnerability to unfavorable economic and business forces.
Portfolio Management Technology Can Help Gauge Volatility
Investing in and valuing multiple asset classes is no easy task and should be approached carefully – and with the right analytical and reporting tools, particularly if private and/or illiquid investments are in the mix.
Pro forma interfaces need to represent the portfolio in its entirety in order to offer asset value insight for institutional investors. This can be very challenging without a platform that can model investments like private equity, applying desired drawdown return assumptions and customized J-Curves, alongside all other asset classes. At the same time, the institutional investor may still wish to model other investments in the portfolio using more standard performance methods based on currently available public market data.
In other words, technology must be flexible enough to apply model constructs that cater to the highly unique attributes of the individual asset classes (or some other portfolio grouping properties), within the same portfolio. Only then can the appropriate optimization techniques be applied, drift be managed across the array of investments, the impact of upcoming investments and associated events and transactions be fully understood, and thus, volatility be properly managed. Most products available to asset owner and allocators can only produce monthly updates, which are rendered completely ineffective when an event of the COVID-19 magnitude hits the globe. Only a daily platform that can take in and immediately assess information can provide what’s required to manage through this level of volatility.
The volatility of investments, particularly today, is a widely recognized problem for institutional investors. Modern portfolio management technology can give institutional investors the ability to improve transparency across an entire multi-asset class portfolio, project future performance and provide more informed insights to investment teams.
To find out more about how true multi-asset class portfolio analysis can help investors gauge volatility and inform asset allocation and management decisions across all asset classes, giving you a framework for enabling true innovation, explore the Solovis platform.
This article was originally published on Solovis.com.