Private Equity Fair Market Value Model Background
Hamilton Lane conducts a regression analysis on historical quarterly private markets fund valuations against relevant public market indices and, based on the results, developed a model to estimate quarterly private markets fund valuations given a known quarter over quarter index value change. The regression analysis and model segments funds by investment strategy, fund size, and geography. The regression analysis shows, with statistical significance, that private markets fund valuations are correlated to relevant public market indices, with typical Beta values positive and less than one (i.e. fund valuations generally move in the same direction as the market, but with potentially less volatility).
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To estimate the quarterly valuation of a fund or portfolio, apply the estimated quarterly growth rate given in the attached table. The quarterly growth rate should be applied after adjusting for all fund contributions and distributions made during the quarter. The predicted growth rate is in USD, and therefore does not take into account a change in exchange rates that may also impact valuations. The predicted FX effect should be applied to the predicted growth rate prior to using it, as shown in the equation below. For quick reference, the USD/EUR movement is shown in the attached. Other FX rate changes can be found using Bloomberg or another financial data resource.
Predicted Ending NAV = (Beginning NAV)(1 + Predicted Growth + FX Effect) + (1 + (Predicted Growth + FX Effect)/2)(Period Capital Calls - Period Distributions)
Example 1: USD investor in USD Energy Fund: [Predicted Growth Range] + FX Rate = [(3.7%) - 0.3%] + 0.0% = Between (3.7%) and 0.3%
Example 2: USD investor in EUR SMid Fund: [Predicted Growth Range] + FX Rate = [(6.8%) - (2.8%)] + (5.3%) = Between (12.1%) and (8.1%)
Using this methodology, clients may predict the ending valuations for each specific fund and sum these to predict the total ending valuation of their portfolio.
Please note that these estimates are only a rough guidance and are based on predicting the movement in valuations for the industry as a whole. Similarly, once actual valuations are known, we may see that larger portfolios follow the prediction model more closely than smaller portfolios.
Please note that the regression analysis shown above is based on Hamilton Lane data and should not be used as the basis for an investment decision. There are a number of factors that can affect the private markets which can have a substantial impact on the results included in this analysis. There is no guarantee that this analysis will accurately reflect actual results which may differ materially. All information contained herein is based on information available to Hamilton Lane as of the date of the presentation and is subject to change. Periods of heightened volatility and uncertainty, such as the ongoing COVID-19 crisis, may cause actual valuations to deviate from the forecasts in this analysis. Forecasts may exhibit greater error during periods of extreme volatility and valuations may see a more modest increase than the historical relationship with public markets would otherwise indicate. Please refer to the following pages for important endnotes, definitions, and disclosures.
The projections published herein are based on a regression of quarterly public market index returns against quarterly private market index returns. This regression generates an alpha and a beta by strategy which can be used as inputs into the single-index model of pricing assets (Sharpe 1964, Lintner 1965). The formula for the single-index model is:
𝑟𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠=𝛼𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠+𝛽𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠(𝑟𝑃𝑢𝑏𝑙𝑖𝑐 𝑀𝑎𝑟𝑘𝑒𝑡𝑠−𝑟𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒)+𝑟𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒
𝑟𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠=𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑓 𝑡ℎ𝑒 𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠
𝑟𝑃𝑢𝑏𝑙𝑖𝑐 𝑀𝑎𝑟𝑘𝑒𝑡𝑠=𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑓 𝑡ℎ𝑒 𝑃𝑢𝑏𝑙𝑖𝑐 𝑀𝑎𝑟𝑘𝑒𝑡𝑠
𝛼𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠=𝐴𝑙𝑝ℎ𝑎 𝑜𝑓 𝑡ℎ𝑒 𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠
𝛽𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠=𝐵𝑒𝑡𝑎 𝑜𝑓 𝑡ℎ𝑒 𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠
𝑟𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒=𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒 𝑅𝑎𝑡𝑒
The regression formulas for Core and Non-Core Real Estate differ slightly from the single-index model in that the regressions are multi-index models, which include multiple betas and public market returns to better predict private market returns, such as the U.S. Regression Indicator Index.Once all inputs are obtained, we create a 75% confidence interval for our expected returns. This should denote the inherent uncertainty in these sorts of predictions. In general, we expect to be accurate within a 400 basis point spread with 75% confidence in quarters of normal stock market volatility. During periods of outsized positive or negative returns in the public markets, we would expect to either be less accurate or for the confidence interval to expand meaningfully. We also expect individual portfolios to vary meaningfully from these projections, as individual portfolio returns vary from the industry’s returns for many reasons, including concentration of assets, different investment pacing, and different strategy/geography makeups, to name a few. Larger and more mature portfolios should be expected to have a performance more similar to the market, and therefore more reflective of these estimates, than other portfolios might be.
To estimate the next quarter’s valuation for a portfolio, you can apply the estimated quarterly growth rate associated with it. The quarterly growth rate should be applied after adjusting for all fund contributions and distributions made during the quarter, in accordance with the Simple-Dietz methodology for calculating returns. Note that all calculations shown in the document are in USD. Therefore, the formula for calculating 𝑟𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠 shown above yields a return in USD. To apply the 𝑟𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠 to a portfolio with valuation and cash flow information already in USD, use the formula below:
P𝑟𝑒𝑑𝑖𝑐𝑡𝑒𝑑 𝑁𝐴𝑉𝐸𝑛𝑑𝑖𝑛𝑔=(𝑁𝐴𝑉𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔)(1+𝑟𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠)+ ((1+𝑟𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠)/2)(𝑃𝑒𝑟𝑖𝑜𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐶𝑎𝑙𝑙𝑠‐𝑃𝑒𝑟𝑖𝑜𝑑 𝐷𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛𝑠)
If the portfolio valuation and cash flow information is not in USD OR you wish to convert a USD return to a non-USD currency, an “FX Effect” factor must be applied. The formula should be adjusted as shown below:
𝑃𝑟𝑒𝑑𝑖𝑐𝑡𝑒𝑑 𝑁𝐴𝑉𝐸𝑛𝑑𝑖𝑛𝑔=(𝑁𝐴𝑉𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔)(1+𝑟𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠+𝐹𝑋 𝐸𝑓𝑓𝑒𝑐𝑡)+ (1+(𝑟𝑃𝑟𝑖𝑣𝑎𝑡𝑒 𝑀𝑎𝑟𝑘𝑒𝑡𝑠+𝐹𝑋 𝐸𝑓𝑓𝑒𝑐𝑡)/2)(𝑃𝑒𝑟𝑖𝑜𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐶𝑎𝑙𝑙𝑠‐𝑃𝑒𝑟𝑖𝑜𝑑 𝐷𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛𝑠)
For our model, we define the private market indices as follows:
All Private Markets: Hamilton Lane’s definition of “Private Markets” includes all private commingled funds excluding fund-of-funds and secondary fund-of-funds.
Core Real Estate: As a proxy for a PM fund that has a strategy of core real estate, we use the net appreciation return of NCREIF’s NFI-ODCE Value Weighted Index.
Credit – Distressed: Includes any PM fund that primarily invests in the debt of distressed companies.
Credit – Origination: Includes any PM fund that focuses primarily on providing debt capital directly to private companies, often using the company’s assets as collateral.
Energy: Includes any natural resources fund that primarily invests in energy investments
European Mega/Large: Any buyout fund larger than a certain fund size that depends on the vintage year that is primarily investing in Western Europe.European SMID: Any buyout fund smaller than a certain fund size, dependent on vintage year that is primarily investing in Western Europe.
Infrastructure: Includes any PM fund with a strategy of infrastructure.
Non-Core Real Estate: Includes any PM fund with a strategy of real estate that is not core real estate.
ROW Equity: Includes all buyout, growth, and venture capital-focused funds, with a geographic focus outside of North America and Western Europe.
U.S. & European VC/Growth Equity: Includes all funds with a strategy of venture capital or growth equity that are primarily investing in the United States or Western Europe.
U.S. Mega/Large: Any buyout fund larger than a certain fund size that depends on the vintage year that is primarily investing in the United States.
U.S. SMID: Any buyout fund smaller than a certain fund size, dependent on vintage year that is primarily investing in the United States.
For our model, we define the public market indices as follows:
Credit Suisse High Yield Index: The Credit Suisse High Yield index tracks the performance of U.S. sub-investment grade bonds.
FTSE Nareit U.S. Equity REITs: The FTSE Nareit Equity REITs index tracks the return of U.S. equity REITs ex dividends.
FTSE Nareit U.S. Equity REITs Price Return: The FTSE Nareit Equity REITs index tracks the price return of U.S. equity REITs.
MSCI Emerging Markets: The MSCI Emerging Markets Index is a free-float weighted equity index that captures large and mid cap representation across Emerging Markets countries. The index covers approximately 85% of the free float-adjusted market capitalization in each country.
MSCI World Index: The MSCI World Index tracks large and mid-cap equity performance in developed market countries.
NASDAQ 100: The NASDAQ-100 Index is a modified capitalization-weighted index of the 100 largest and most active non-financial domestic and international issues listed on the NASDAQ.
NFI-ODCE Value Weighted Index:The NCREIF NFI-ODCE Value Weighted Index tracks 38 open-ended commingled real estate funds that purse a core investment strategy.
Risk Free Rate: 10-Year U.S. Treasury Yield
Russell 3000 Index: The Russell 3000 Index is composed of 3000 large U.S. companies, as determined by market capitalization.S&P 500 Index: The S&P 500 Index tracks the 500 largest companies based on market cap of companies listed on NYSE or NASDAQ.
S&P Global 1200 Energy Index: The S&P Global 1200 Energy Index includes all constituents included in the S&P Global 1200 that are classified under the GICS Energy sector.
S&P Global Infrastructure Index: The S&P Global Infrastructure Index includes 75 companies that are meant to represent the infrastructure industry.
STOXX Europe 600: The STOXX Europe 600 Net Total Return index represents 600 large, mid and small capitalization companies across 17 European countries.
STOXX Europe Large 200: The STOXX Europe Large 200 Net Total Return Index tracks the 200 largest companies from 17 European nations by market capitalization.
U.S. Recession Indicator: The U.S. Recession Indicator is a dummy indicator based off of the returns of the Russell 3000 Index. If the Russell 3000 has two consecutive quarters of negative returns, then the indicator is 1; otherwise, it is 0.
This document has been prepared solely for informational purposes and contains confidential and proprietary information, the disclosure of which could be harmful to Hamilton Lane. Accordingly, the recipients of this document are requested to maintain the confidentiality of the information contained herein. This document may not be copied or distributed, in whole or in part, without the prior written consent of Hamilton Lane.
There are a number of factors that can affect the private markets which can have a substantial impact on the results included in this analysis. There is no guarantee that this analysis will accurately reflect actual results which may differ materially. These valuations do not necessarily reflect current values in light of market disruptions and volatility experienced in the fourth quarter of 2020, particularly in relation to the evolving impact of COVID-19, which is affecting markets globally.
The information contained in this presentation may include forward-looking statements. Forward-looking statements include a number of risks, uncertainties and other factors beyond our control which may result in material differences in actual results, performance or other expectations. The opinions, estimates and analyses reflect our current judgment, which may change in the future.
All opinions, estimates and forecasts contained herein are based on information available to Hamilton Lane as of the date of this presentation and are subject to change. The information included in this presentation has not been reviewed or audited by independent public accountants. Certain information included herein has been obtained from sources that Hamilton Lane believes to be reliable but the accuracy of such information cannot be guaranteed.
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As of July 6, 2022