Private Markets Valuation: How Unlisted Investments Are Priced

One of the most consistent observations made by investors who allocate to private markets for the first time is how pleasingly stable their valuations appear. While a public equity portfolio might oscillate 10–20% over a quarter, a private equity fund typically reports modest quarterly value changes, producing a smooth upward-sloping return chart that bears little visual relationship to the turbulence in public markets.

This stability is largely an artefact of the valuation methodology — not evidence of lower economic risk. Understanding how private markets are valued, what the implications are for portfolio analytics, and how investors should interpret private asset performance is essential before committing meaningful capital to the sector.

Why Valuation Is Different in Private Markets

Listed securities are valued continuously. Every time a share changes hands on the London Stock Exchange, a new price is established that is immediately observable, transparent, and binding for all shareholders.

Private companies and other unlisted assets have no such mechanism. Valuations must instead be estimated by the managers of private funds, who use methodologies that are inherently judgemental, infrequent, and subject to conflicts of interest (because the manager's fees and carry are partly driven by reported values).

This means:

• Infrequency: Private assets are typically valued quarterly (some annually) — not daily.
• Subjectivity: Multiple legitimate methodologies exist, and different assumptions produce different valuations.
• Lag: Valuations reflect information available at the valuation date, which may be weeks or months before it is reported to investors.
• Smoothing: Because valuations do not change continuously, the reported return series appears smoother than the underlying economic reality.

Core Private Markets Valuation Methodologies

Fair Market Value (IFRS 13 / IPEV Guidelines)

International private equity funds follow the International Private Equity and Venture Capital (IPEV) Valuation Guidelines, which are broadly aligned with IFRS 13 (Fair Value Measurement). The standard requires that assets be valued at the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date — the "exit price" concept.

In practice, this means the manager must estimate what a willing buyer would pay for the asset today, drawing on observable market inputs where possible.

Comparable Company Analysis (Comps)

The most common methodology for private equity-backed companies. The process:

1. Identify a set of publicly listed companies comparable to the investee in terms of sector, size, geography, and business model.
2. Derive a relevant valuation multiple from these comparables — typically EV/EBITDA (Enterprise Value / Earnings Before Interest, Tax, Depreciation, and Amortisation) for mature businesses; EV/Revenue for high-growth early-stage companies.
3. Apply the multiple to the investee company's own EBITDA (or revenue), with adjustments for size discount, liquidity premium, growth rate, or quality differences.
4. Deduct net debt and add/subtract other adjustments to arrive at equity value.

Key sensitivity: This methodology directly ties private company valuations to public market multiples. When public market valuations fall (as in 2022), the comparable company multiples fall — and private equity valuations must eventually reflect this, even if with a lag.

Discounted Cash Flow (DCF) Analysis

A DCF estimates the present value of all future cash flows from the asset, discounted at a rate reflecting the risk of those cash flows. DCF is commonly used for:

• Infrastructure assets (predictable, long-duration contracted revenues)
• Private credit positions (scheduled interest and principal payments)
• Real estate (discounted rental income stream)

Key sensitivities:

• Discount rate (cost of capital): When interest rates rise, the appropriate discount rate typically rises too, reducing the present value of future cash flows. Assets that reported stable values in 2021 (when rates were near zero) faced legitimate valuation pressure in 2022–2023 as rates rose sharply.
• Terminal value: For growth companies, a large proportion of DCF value sits in the terminal value (value beyond the explicit forecast period). Small changes in assumptions have a disproportionate impact.

Precedent Transactions

Where comparable acquisitions or secondary transactions in similar assets have occurred recently, these transactions provide market evidence of value. This is the most objective input but is often unavailable or stale.

Recent Transaction Price

Where the fund manager has recently invested in or exited a position, the transaction price provides direct market evidence of value for the same or a similar stake. This is typically used as the primary basis for newly acquired positions.

NAV-Based Approaches (for funds of funds)

When a private equity or private credit fund holds stakes in other funds, the primary valuation basis is the NAV reported by the underlying fund manager, subject to any additional adjustments the fund of funds manager believes are warranted.

The Conflict of Interest Problem

Private fund managers determine their own asset valuations, typically with oversight from an independent auditor. This creates an inherent conflict: the manager's carried interest (performance fee) increases as valuations rise; the manager's track record is enhanced by positive reported performance; and fundraising for the next fund is easier when current fund performance appears strong.

Institutional investors mitigate this conflict through:

• Independent valuation committees with external advisers
• Annual audits by major accountancy firms (though audit quality on private markets valuations is inconsistent)
• Monitoring comparable public companies as a cross-check
• Secondary market pricing as an alternative signal (see below)

Despite these mitigations, academic research consistently shows that private fund valuations are smoother than warranted by underlying economic reality, and that managers have historically "managed" valuations to avoid large negative quarters — reducing volatility artificially.

The Secondary Market: A More Honest Valuation Signal

A secondary market exists for limited partnership interests in private equity funds — where existing investors sell their stakes to secondary buyers. These trades occur at discounts or premiums to the fund's reported NAV:

• At a discount: The secondary buyer believes the reported NAV overstates true value, or demands a discount for taking on illiquidity. Discounts of 20–40% were common for private equity stakes in 2022–2023 as rising rates and public market falls reduced the expected value of underlying portfolios.
• At a premium: Demand exceeds supply (common for highly sought-after flagship funds); or the buyer believes the current NAV understates what will be achieved on exit.

Secondary market pricing is arguably the most informative external signal of private asset values, because it reflects actual negotiated transactions between sophisticated parties with incentives aligned to accurate pricing. When secondary market discounts are wide, it often signals that reported NAVs are temporarily elevated relative to market consensus.

The Implications for Portfolio Analytics

Understated volatility

Because private assets are valued infrequently, their reported volatility in portfolio analytics is significantly lower than the true economic volatility of the underlying business or asset. This understated volatility creates misleading portfolio statistics:

• Sharpe ratio: If the denominator (volatility) is artificially low, the Sharpe ratio appears artificially high.
• Portfolio diversification: Correlations between private assets and public markets appear low — partly because they are measured against stale, smoothed private valuations, not real-time ones.
• Drawdown: A private equity portfolio might report its worst quarter as -5% during a financial crisis while equivalent public equities fall 30%. The economic losses of the private portfolio are real but unreported.

Sophisticated investors adjust for this by "de-smoothing" private asset return series before incorporating them into portfolio analytics — using techniques that attempt to reconstruct the underlying economic volatility from the reported series.

J-curve effect

New private equity funds typically show negative early returns before generating positive performance. This "J-curve" effect occurs because:

• Management fees are charged from day one
• Portfolio companies take time to implement value creation strategies
• Early exits (realisations) occur before value has been fully built

Fund performance metrics typically show a gradual improvement in Internal Rate of Return (IRR) and TVPI (Total Value to Paid-In) over the fund's life. Investors comparing private equity to public equities must account for this pattern — early underperformance is expected and does not indicate poor manager selection.

What to Look For When Evaluating Private Fund Performance

• Realised vs unrealised value: How much of the reported TVPI comes from actual cash distributions vs paper appreciation? Unrealised appreciation can be revised down; distributions are permanent.
• DPI (Distributions to Paid-In Capital): What multiple of invested capital has actually been returned to investors in cash? DPI is the most conservative performance measure.
• Vintage year comparison: Compare performance against funds of the same vintage year, not across time. A 2009 vintage fund benefited from buying at crisis lows; a 2021 vintage fund bought at near-peak valuations.
• Fee structure: Total Expense Ratio including management fee, carried interest, and fund expenses. Net-of-fee returns are what matters.

Compliance Note

Private market investments involve significant illiquidity, valuation uncertainty, and complexity. Reported valuations may not reflect realisable value and are subject to material revision. Past performance of private equity, private credit, or other unlisted assets is not a reliable guide to future returns. Minimum investment thresholds are typically high, and many private market funds are restricted to professional or sophisticated investors. Tax treatment depends on jurisdiction and individual circumstances. This guide is educational and does not constitute personal financial advice. Seek qualified advice before investing in private markets.

How Global Investments Can Help

Global Investments advises HNW clients on private markets allocation — from selecting appropriate managers and fund structures to understanding valuation methodologies and liquidity constraints. We provide independent analysis of private fund performance, help clients navigate secondary market opportunities, and integrate private markets exposure within their overall portfolio and tax planning framework. Contact our team to discuss private markets as part of your investment strategy.