Trust is the basis for Ireland’s strong reputation in funds valuations

Over the past 30 years Ireland has gained a reputation as a highly attractive location for funds. A key reason is the trust that has been built in the sector, says Cian Higgins, head of quantitative solutions with Mazars Ireland, due in no small part to compliance with UCITS and AIFM directives, and a robust regulatory framework.

For investors, a key consideration when investing in funds is the valuation of their investments. They can take comfort, Higgins says, from the rules that exist within the UCITS (Undertakings for Collective Investment in Transferable Securities) and AIFMD (Alternative Investment Fund Manager) frameworks on the policies and procedures that must be adhered to and the disclosures required. “These have come under close attention from regulators – in particular when considering less liquid assets such as unlisted equities, unrated bonds and real estate,” he adds.

In January 2022 the European Securities and Markets Authority (ESMA) launched a common supervisory action on the supervision of asset valuation rules under the UCITS and AIFM directives. Its aim was to assess compliance with asset-valuation requirements and its focus was centred on less liquid assets.

“This is because these assets are more impacted by valuation issues, specifically under stressed conditions,” Higgins explains. “The results, released in May 2023, outlined areas of improvement that should be addressed. These included the appropriateness of valuation policies, valuation under stressed market conditions, independence of the valuation function, and use of third-party valuers and early detection mechanisms for valuation errors and compensation to investors.”

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These areas for improvement become more important in fostering trust when we think of European Long-Term Investment Funds (ELTIFs). Originally ELTIFs, introduced in 2015, were designed to boost retail investment in long-term projects across Europe by channelling money into asset classes such as infrastructure projects, real estate and SMEs.

“Earlier this year there were fewer than 100 ELTIFs authorised to operate,” says Higgins. “However, this is expected to change with ELTIF 2.0 becoming applicable in January 2024, making them more attractive by simplifying investment conditions.”

When the types of assets ELTIFs invest in are considered, accurate and timely valuations become critical to ensure investor trust, Higgins adds. “But also, as more investors invest in private funds and alternative assets, the valuation process becomes crucial for accurately determining the value of their investment. Transparent and trustworthy valuation practices instil confidence, which attracts and retains investors.”

Valuations also play a crucial role in risk management. “Fund managers use valuation data to assess the risk exposure of their portfolios, make asset allocation decisions and monitor the fund’s overall performance,” says Higgins. “Accurate valuations enable managers to identify potential risks, adjust investment strategies and mitigate adverse effects on the fund and its investors.”

Higgins notes the impact on private investment markets of the benign period of low interest rates and subdued returns post the 2007-2009 financial crisis. “In a search for better returns by institutional investors, private investment markets have swelled since 2009. For example, when we think of the private equity funds market – which is unregulated – the amount of money invested or waiting to be invested by private equity funds has increased from $1.3 trillion in 2009 to $4.6 trillion as of last year. This trend continues, with recent reports of Calpers, the biggest US public pension fund – an already large investor in private equity – having an appetite to increase their holdings once again in private equity.

“The Covid Pandemic and the Russian invasion of Ukraine, set against a backdrop of increasing interest rates and high inflationary pressure, have impacted the returns from private equity markets but some would take the view that the dips in valuation during these stressed periods are not being fully factored in. While these markets are largely unregulated, they are sure to attract more attention going forward and a robust and high standard applied to the valuation process will be key to maintain trust.”

By implementing independent valuations, standardised practices, robust governance and regulatory compliance, the industry can strengthen trust and safeguard the integrity of funds valuations, Higgins contends. “Independent third-party experts should be brought in to further strengthen valuation procedures, implement policies and controls or perform an independent assurance review.”

In terms of the actual valuations, it is imperative that the process is transparent. “That is why when providing valuations to clients we understand that simply providing a value is not sufficient,” Higgins concludes. “In order for funds and investors to be able to place reliance on these it is important there is an understanding of how valuations were derived, particularly in less liquid assets. Reliable valuations are essential to maintaining the trust built in the funds sector and transparency is crucial.”