PitchBook News - How fair value accounting skews returns

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The Research Pitch

June 5, 2021

"Desmoothing" private market returns can dramatically alter volatility and correlation estimates

The lack of transparency in private markets has helped attract institutional investor capital through the potential for outsize returns from an inefficient market.

In some ways, however, this opaqueness has created significant challenges to how asset allocators have traditionally built and managed portfolios.

Traditional multi-asset portfolio management has relied heavily on modern portfolio theory, which requires accurate estimates of asset classes' return and risk characteristics and their relationships with other asset classes.

But accurately estimating the risk of private market asset classes is difficult because investments are only valued by the market when they're bought or sold.

In all other periods, the values of private investments are self-reported by the GP, based on "fair value" accounting principles.

As covered in our new research, fair value accounting has been shown to understate the changes in the true value of private investments from quarter to quarter, which in turn leads to artificially smoothed returns and lower volatility.

For example, after "desmoothing" PitchBook's quarterly PE return series, the estimated annualized volatility increases from 9.8% to 17.1%.

The effect of desmoothing on the volatility of VC returns is even greater, more than doubling from 21.1% to 53.2%.

For this reason, it's imperative for asset allocators to apply a desmoothing procedure to reported private market return series prior to calculating volatility, particularly when it's being used as an input to asset allocation modeling.

Failure to do so can lead investors to misinformed asset allocation decisions that favor larger allocation to private markets:

Read our analysis: "Return Smoothing in Private Markets"

Feel free to reach out to me or our institutional research group with any feedback or questions.

Best,

Andrew Akers
Senior Data Analyst

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Market Updates

European VC valuations hit new records in 2020.

Q1 2021 took them even further—and that's across the board at all financing stages and quartiles, according to our new European VC Valuations Report.

For startups and deal terms, the increased presence of deep-pocketed nontraditional investors has more than made up for headwinds including intermittent lockdowns, rising unemployment, and unpredictable economic growth.

Rising exit valuations have also justified the expense:

read the free report

Emerging Tech Research

RETAIL HEALTH & WELLNESS TECH: Q1's new record of $4.2 billion in capital invested goes a long way toward illustrating the demand for consumer-focused healthcare products.

And our analysts expect investment to remain robust for the rest of the year. Other highlights from our Q1 report on retail health & wellness tech:

Two subsectors driving investment are virtual health and personalized medicine & testing.

Even as people return to gyms, digital opportunities in fitness tech remain strong.

When it comes to treating chronic diseases, remote patient monitoring devices provide strong outcomes at low costs.

Exclusively available to clients, the report also features an updated market map and select startups to watch.

Non-clients can access a preview of the report .

AGTECH: Pollination tech, shelf-life extension and harvest robots represent emerging opportunities in agtech, according to our new research on the sector.

Some other key takeaways:

Issues like labor shortages and food waste continue to spur tech innovation and investment.

Agtech startups raised over $1.5 billion in Q1, passing that mark for the fourth straight quarter.

High food prices show there's little room for error in supply chains as we come out of the pandemic.

Our Q1 report on agtech, exclusively for clients, features a timeline of key events, updated charts and datasets, and all of our latest insights.

Non-clients can access a preview of the report .

Events Calendar

There are plenty of new opportunities to hear from our analysts in the coming weeks:

June 8: In a session put on by CFA Seattle, analysts Hilary Wiek and Kyle Stanford will talk about accessing the VC markets. Details here.

June 9: As part of a cybersecurity speed pitch event, analyst Brendan Burke is moderating a panel discussion of startup CEOs. Details here.

June 9: Analysts Joshua Chao and Kaia Colban will discuss biotech and pharma's record 2020 and where the industry is going. Register here.

June 22: We've partnered with the BVCA on a new series of fireside chats, the first of which will feature our department head, Nizar Tarhuni, and Scott Ramsower from the Teacher Retirement System of Texas. Exclusive to BVCA members.

June 24: As an extension of today's top story, our analysts will take a look at the smoothing of private market fund returns. Register here.

Deal Commentary

Information security analyst Brendan Burke weighs in on AI/ML cybersecurity provider SentinelOne after the company filed for an IPO:

"SentinelOne is an extended detection & response (XDR) vendor with managed services for endpoint and cloud threat detection.

"The company leverages machine learning to correlate disparate data points and stands out in the market for the quality and transparency of its machine learning technology.

"Its Singularity Platform integrates IoT security and cloud workload protection, tapping two of the highest-growing categories in information security.

"Due to its early movement in cloud workload protection, we believe SentinelOne is positioned to carve out a niche in the nascent XDR market.

"The company's success will depend on the expansion of the endpoint security market's TAM to include cloud security, IoT device monitoring, and general IT monitoring use cases."

Brendan Burke

Senior Emerging Technology Analyst
Information Security, AI/ML

In the News

Our insights and data featured in the press:

In this exploration into VC micro-funds, analyst Joshua Chao explains the importance of PR and your online presence. [Forbes]

The latest research from health & wellness tech analyst Kaia Colban served as the foundation for this look at one of VC's hottest industries. [Institutional Investor]

Instacart is seeking to bring automation to online grocery delivery in a big way, and analyst Asad Hussain weighs in on the plans. [Bloomberg]

How are public companies valued differently in the US versus the UK? Analyst Dominick Mondesir has the numbers. [Investors Chronicle]

If you're a media member interested in interviewing our analysts, contact our PR team.

ICYMI

Highlights from our other research content published this quarter:

Market updates

Thematic research

Emerging Technology Research (report previews)

Coming next week (subject to change)

Q1 Emerging Tech Indicator (new!)
VC Manager Style Drift
Manager Behavior After Selling a GP Stake
Exploring Long-Dated PE Funds
ETR: Fintech

Thanks for reading! Feel free to email us any time with feedback, questions or tips!

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PitchBook News - How fair value accounting skews returns

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