Nick Dignam from Fortitude Investment Partners shares insights with Lachlan Maddock from Fortitude Investment Partners on how a diversified portfolio in mid-market private equity is structured. The Inside Adviser
The world of alternative investments is at a crossroads. As markets defy expectations and liquidity concerns take centre stage, investors find themselves forced to rethink how they deploy capital in an increasingly complex environment.
When it comes to valuation, ‘a lot of people don’t know what they’re doing’: Avari
Valuation sits at the foundation of the private credit market, allowing lenders to properly assess risk and return and give their own investors peace of mind that their money is in safe hands. But what should be a science is often more like an art – and there’s lots of bad art out there.
That’s because many valuations use historical rather than contemporaneous market data and are made with the assumption that assets can be sold or leased, given enough time. Then there’s the agency problem to contend with – valuers are naturally incentivised to provide a higher valuation.
“If the borrower has a default, the market isn’t going to look at the valuation from the point of view of what the neighbouring property sold for,” says Alan Liao, founder and managing director of real estate fund manager and lender Avari Capital Partners, told The Inside Network’s Income and Defensive Assets Symposium.
“The market is going to look at the economic value of that piece of real estate, and especially in development land that’s what you can potentially build on it and sell it for, minus the cost of construction and the profit of margin that requires for the developers. We spend a huge amount of time identifying the real economic value of the real estate – and most of the time it’s not what the valuation report says.”
That doesn’t mean a valuation sheet isn’t useful as a starting point – it’s just that it doesn’t give you the true, intrinsic value of the property. And that’s important when private credit is one of the hottest asset classes around and new managers are entering the space every day.
“A lot of people don’t know what they’re doing; that’s just the reality,” Liao said. “They wake up and think they can become a fund manager. A lot of the time it’s about telling a story rather than finding out what’s factual and what’s not. Many of them don’t have a thorough due diligence process, in fact many of them don’t have a due diligence process. And they’re lending against any random valuation they can get their hands on as long as it’s a nice story they can tell investors.”
Eventually, the market will take care of those managers that shouldn’t be in it. But until then,
investors will need to do serious due diligence of their own.
“Investors need to rely on their financial advisers, and we’ve raised most our monies through financial advisers,” Liao said. “They have the knowledge to tell good and bad managers apart. And then we open the due diligence sheet to advisers or potential clients and go through it item by item. And there’s hundreds of pages of information there. That way they know we put the work in.”
“The key thing that investors need to understand is the kind of work that’s being done, and that should be documented. Any decent manager will document their due diligence process so that it’s easy for an investor to ask for that documentation. Most managers don’t have that; it’s not about ‘it’s a nice location, it’s a good developer, they’re going to make lots of money’ – that’s all opinion. It’s not factual.”
