Unigestion has developed a new framework to assess risk in private equity.
Existing risk measures in private equity are typically founded on the input of either self-reported interim valuations or final multiples. While this data allow risk calculations to be performed easily, the company believes such analysis is ultimately unsatisfactory. Intermediate valuations significantly understate true risk due to the self-referring nature of private equity returns, while final multiples rely on 10 to 12 years of history and therefore will only illustrate a fund’s performance once it has been liquidated rather than throughout its entire life.
Unigestion has therefore designed a risk measure called expected cumulative downside absolute deviation (ECDAD), which uses fund cash flows as an input and measures the difference between the actual cash flow curve and the expected cash flow curve, retaining as risk the amounts where actual cash flows are lower than expected cash flows.
It says this measure presents significant advantages as it results in a single number, allowing an easy comparison between funds, while nevertheless taking both the magnitude and timing of distribution into account.
“There is a very clear need for improved risk assessment in private equity portfolios,” explains Hanspeter Bader, managing director and head of private assets at Unigestion. “We have already seen significant benefits in applying the ECDAD measure to our investment analysis, enabling more effective risk management and diversification.”
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