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Marks swims against the tide on private valuations

In his latest investment missive, Howard Marks pushes back on the controversy around private markets, saying valuations shouldn’t reflect the psychological swings that dominate public markets.

Howard Marks’ latest memo, titled ‘What Really Matters?’, deals with – as its title suggests – what does and does not matter in investing. The things that matter are the things that usually matter to Marks or any other savvy investor: forget the short-term, think about your normal risk posture, recognise that psychology swings more than fundamentals.

The things that don’t matter are hyper-activity (trading too much in order to justify fees), short-term performance, and volatility. Even Marks admits that it’s boilerplate stuff, though it does bear thinking about at times like these.

But one interesting aside (perhaps borne from his recent visit to Australia, where it seems to be the most pressing consideration for superannuation funds and their observers) is private market valuations.

Marks notes Financial Times coverage of an academic article that claims that general partners (GPs) manipulate their interim returns, not to fool their limited partners (LPs) but because their LPs want them to – which might, to Marks’ mind, explain why private equity firms on average reported gains of 1.6 per cent in the first quarter of 2022 and only some “modest mark downwards” since then while global equities lost 22 per cent of their value.

“If both GPs and LPs are happy with returns that seem unusually good, might the result be suspect?” Marks writes. “Is the performance of private assets being stated accurately? Is the low volatility reported genuine? If the current business climate is challenging, shouldn’t that effect the prices of public and private investments alike?”

But there’s “another series of relevant questions”.

“Mightn’t it be fair for GPs to decline to mark down private investments in companies that experienced short-term weakness but whose long-term prospects remain bright?” Marks writes. “And while private investments might not have been marked down enough this year, isn’t it true that the prices of public securities are more volatile than they should be, overstating the changes in long-term value? I certainly think public security prices reflect psychological swings that are often excessive. Should the prices of private investments emulate this?”

“As with most things, any inaccuracy in reporting will eventually come to light. Eventually, private debt will mature, and private equity holdings will have to be sold. If the returns being reported this year understate the real declines in value, performance from here on out will likely look surprisingly poor.”

Of the other things that “matter”, what matters most to Marks is asymmetry: the ability for fund managers to do better than everybody else when things are going well and less bad than everybody else when they aren’t.

“A great adage says, ‘Never confuse brains and a bull market’,” Marks writes. “Managers with the skill needed to produce asymmetry are special because they’re able to fashion good gains from sources other than market advances.”

“When you think about it, the active investment business is, at its heart, completely about asymmetry. If a manager’s performance doesn’t exceed what can be explained by market returns and his relative risk posture – which stems from his choice of market sector, tactics, and level of aggressiveness – he simply hasn’t earned his fees… Indeed, all the choices an active investor makes will be for naught if he doesn’t possess superior skill or insight.”

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