Recent Developments in the Financial Markets & Unlisted Asset Valuations
Current financial market conditions are extremely unusual. The investment environment has become very dynamic in recent months with significant falls in the prices of most listed equities since 30 June 2008 being exacerbated by the sharpest fall in the Australian dollar since it was floated in 1983. These falls reflect growing concerns about the global financial system and a sharp slowdown in global growth.
Westscheme’s investment strategy aims to maximise member returns over the long term, while providing some protection against falls in listed equity markets. This is achieved by investing in a diverse range of listed and unlisted assets via a two portfolio approach. Westscheme’s Market Portfolio consists of listed asset classes such as cash and equities, while the Target Return Portfolio consists of unlisted assets such as infrastructure, direct property, private equity, high yield debt and natural resources.
Industry super funds tend to have a meaningful allocation to alternative or unlisted assets. This has sparked the attention of some members of the financial industry, in particular some in financial planning groups, who argue that the recent sharp falls in listed equity markets bring into question the relevancy of unlisted asset valuations which are updated periodically. The media has also reported the discussion about the valuations of unlisted assets within the portfolios of industry super funds.
As outlined in an article “Westscheme’s approach to valuing its investments” on its website, Westscheme undertakes regular valuations of all assets within the Target Return Portfolio in accordance with long established valuation policies. The frequency of Westscheme’s valuations results from a trade-off that aims to ensure member equity without causing members to incur unnecessarily high costs. To enhance this trade-off, Westscheme generally employs full scale annual valuations as well as more frequent valuation updates. Valuation updates incorporate changes to the annual valuation model that account for newly available information which is material and either relates to the asset in question or markets more generally. A key advantage of this valuation framework is that it smoothes returns throughout the year. Where appropriate, Westscheme also aims to spread out the annual valuations (and valuation updates) of unlisted assets throughout the year to avoid concentrating valuations at financial year end. More details of the frequency of valuations can be found here.
Importantly, these valuations are conducted by independent valuers, who are engaged on an asset by asset basis. To this end, Westscheme has broad valuation agreements in place with the top tier accounting firms. In conducting valuations, the independent valuers are responsible for determining the appropriate valuation method. As part of this process, valuers also spend considerable time analysing comparable companies and recent transactions as a high level cross check of their chosen method and resulting valuation. This Market Comparable Approach aims to confirm the reasonableness of valuations, particularly during periods of changing market conditions. In this manner, Westscheme’s valuation process ensures that unlisted valuations take into account current market conditions and accurately reflect fair market value.
It is also worth noting that independent valuers are obliged to follow the Australian Accounting Standard 25 (AAS25) “Financial Reporting by Superannuation Plans” in conducting the valuations of Westscheme’s direct infrastructure assets.
For Westscheme’s unlisted pooled funds, such as private equity funds, updated manager valuations are typically obtained on a monthly basis. Westscheme also holds investments in pooled development property funds. The underlying property investments in these funds are only revalued at the time of divestment and are held at the lower of cost or net realisable value during the interim period.
In light of the current investment environment and fast pace of listed equity markets movements, Westscheme recently decided, on advice from its investment consultant, to reduce the independent valuations of some of its unlisted property assets. This decision largely reflects Westscheme’s desire to bring forward the valuation impact that is considered likely to occur over time given the potential for property prices to fall from current levels.
These changes have been incorporated into Westscheme’s October 2008 interim net investment performance rates. As a consequence, the loss reflected in the interim net investment performance of the Trustee’s Selection, Westscheme’s principal (default) investment option used by nearly 97% of its members, has increased by 1.41% to 9.32% for the period from 1 July to 31 October 2008. In the same period, these changes have adversely impacted the performance of the Target Return Portfolio (a component of the Trustee’s Selection) by 3.17%, for a loss of 1.38%. In comparison, the Standard and Poor’s ASX 300 Total Return Index, a common benchmark for listed Australian equities, has fallen by 21.1% over this period.
Westscheme will continue to monitor the investment environment closely to ensure that the valuations of the assets it holds for its members are appropriate and maintain equity between them.
Howard Rosario
Chief Executive
25 November 2008
Previous articles from the Chief Executive are available via the links below:
Developments in the Financial Markets - 29 October 2008
Developments in the Financial Markets - 14 October 2008
Developments in the Financial Markets - September 2008
Westscheme's "Cash" investment option
Westscheme's investment strategy July 2008
Westscheme's approach to valuing its investments
Risks in current investment markets
How has super performed over the long term
Positioning of Westscheme in meeting the challenges of market turmoil