Home / Super / Funds must embrace governance to ensure unlisted asset valuations are fair: Frontier

Unlisted assets deliver high risk-adjusted returns across market cycles but come with inherent challenges, especially around valuation. For super fund trustees, the importance of ensuring accurate valuations to fairness and member equity can't be overstated, says Frontier Advisors.

As the focus on unlisted asset valuations intensifies, it’s becoming increasingly important for trustees to ensure superannuation funds have robust valuation governance procedures and prioritise accurate and conflict-free valuations, according to Frontier Advisors.

“Australian asset owners lead the world when it comes to investing in unlisted assets, particularly in infrastructure and property,” Frontier director of research Paul Newfield and head of investment governance Brett Lazarides wrote in a recent Frontier Line report. These investments have contributed to strong returns over decades for Australia’s $3.4 trillion superannuation sector by delivering higher risk-adjusted returns through different market cycles, they said.

But unlisted assets come with inherent challenges, particularly when it comes to valuation, which is not as straightforward as it is for listed assets.

“Valuing unlisted assets such as property, infrastructure, private equity and private or corporate debt is inherently more involved and uncertain than listed market valuations (as these are known in real time, if not necessarily a more accurate match to fundamental asset value),” Newfield and Lazarides wrote. Unlisted asset valuations are conducted less frequently – usually quarterly or even annually – and thus are less transparent.

This means that valuing unlisted assets accurately is key to trustees’ obligation to ensure fairness and member equity.

Adding to the valuation challenge is the wide range of unlisted investment structures now on offer, with various classes of ownership and tax-effective holding vehicles. As a result, more large funds are adding in-house teams to support unlisted allocations or forming consortiums to better compete for key assets.

As rapidly changing market conditions amplify risk, asset owners and regulators alike have turned their attention to unlisted assets and valuation concerns, the report stated. Investors are now at a “crucial juncture” that sees them subject to greater scrutiny; as fiduciaries, trustees should “continue to embrace strong governance frameworks, which will lead to more accurate valuations”, it said.

“For the first time in decades, asset owners are facing the unprecedented intersection of several factors including significantly higher interest rates and bond yields (which drag down unlisted asset valuations) in a higher inflationary world with heightened macroeconomic uncertainty. Many office properties have not recovered to pre-COVID occupancy levels, raising concerns around current valuation levels, particularly as Australian fund managers have been slower to reduce valuations compared to offshore managers.”

“While there may be good reasons behind those decisions, it requires asset owners to have a strong governance framework in place to evaluate them,” the report concluded.

In the post-pandemic period, Newfield and Lazarides noted, funds were required to release about $35 billion to members through the government’s early-release-of-superannuation scheme in a moment when equity markets were falling. All of this led to a frenzy of scrutiny over how funds valued unlisted assets, and a reckoning that there is room for improvement.

“These concerns have been amplified by the underperformance of listed property assets up to early 2023 compared to unlisted assets, with the gap wider than may be expected based on several decades of history,” they said. Moreover, new regulations, such as an Australian Prudential Regulatory Authority prudential standard requiring super funds to have an adequate valuation governance framework, have prompted trustees to take action.

“Getting valuations correct is a fundamental responsibility for trustees to ensure member equity, particularly in Australia where defined contributions dominate the retirement system,” Newfield and Lazarides said.

To address these concerns, they said, funds should address valuation factors in a systematic way through the valuation governance framework, rather than via an ad hoc approach. “This type of approach will lead to more accurate and nuanced valuations that differentiate between unlisted assets as well as their various subsectors.”

In addition, an independent review can provide assurance that the fund’s valuation framework is effective and compliant and “represents robust, if not leading, industry practice”, they said.

“This can ensure trustees are meeting their fiduciary responsibility to ensure members are treated fairly and equitably across all member options, both listed and unlisted.”