Risk Measurement Guidelines - EVCA

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Interest rates and refinancing terms: Private equityinvestments can be leveraged and private equitymanagers might need to refinance the maturingliabilities of investee companies. Substantial changesin interest rates can affect the value of investeecompanies and the distributed capital to investors.> Foreign exchange exposure: The value of privateequity investments can be affected by foreignexchange volatility where there is a mismatchbetween the reporting currency of the investorand the functional currencies of the fund.4ModellingApproachesLimited partners can use a varietyof models to assess the risk of theirprivate equity investments.Therefore, it is important to exercisegood judgment in selecting the mostappropriate methodology for evaluatingthe risks of particular funds.Investors should consider all materialrisks, including general market riskand specific risk exposure.14 I EVCA Risk Measurement Guidelines 2013
Investors need to consider the following factors whenselecting an appropriate methodology for specific portfolios:> The applicability of the methodology, given the natureof the industry and current market conditions> The ability to reflect all relevant risks to which the fundmay be exposed> The quality and reliability of the data used in eachmethodology> The comparability of funds or transaction data> The stage in the lifecycle of the fundThe most widely used methodologies to measure the risk ofprivate equity investments are based on the assessment ofthe volatility of net asset values (NAVs) and that of cash flows.Modelling inputs should include the fund’s NAV, its undrawncommitments, the remaining life of the partnerships,the maturity of the portfolio, future management fees andsuitable discount rates for discounting cash flows. The lengthof time over which the risk is measured and the level of riskshould reflect the investment horizon and other contingenciesthat are idiosyncratic to a particular investor. For example,this could be measured by calibrating the risk with observedlosses for interests in similar funds over a period of one yearor longer and for a given confidence level. Regulated investorsallocate capital based on the risk calculated in this way.4.1 NAV-time series-based modelling approachNet asset value (NAV)-time series-based methodologies assume that the risks of investments in private equity are mainlyrepresented by the volatility of the fund’s net asset value series. Such methodologies are likely to be appropriate for fundswhose value derives mainly from the value of their existing underlying portfolio companies and for investors with a limitedallocation to private equity.NAV-time series-based modelling approaches aim to replicate the methodology used for publicly tradable assets and measurethe volatility of the fund’s NAV-time series. In principle, this is done by looking at – typically quarterly – value changes of theportfolio. Essentially, the idea is to replicate the daily price movements in public markets and then for the purpose of determining,say, a yearly VaR do a “forward annualisation” (see Figure 1).Figure 1: Forward annualisation (VaR based on NAV volatility)Outcome of specificscenarioProjected rangeof scenariostimet0t1EVCA Risk Measurement Guidelines 2013 I 15
Page 4 and 5: IntroductionInvestors in private eq
Page 6 and 7: 1Key Objectives ofPrivate Equity Ri
Page 8 and 9: Exhibit 1Prior to the financial cri
Page 10 and 11: For this purpose, a risk model for
Page 12 and 13: 3Overview ofMain Risks to beConside
Page 16 and 17: The volatility is estimated by meas
Page 18 and 19: Figure 2: Backward annualisation (V
Page 20 and 21: Exhibit 4How can we calculate a por
Page 22 and 23: Exhibit 4(2) For each scenario i an
Page 24 and 25: In practice, the bottom-up approach
Page 26 and 27: In a buoyant economy, proceeds from
Page 28 and 29: The use of correlation as a measure
Page 30 and 31: II. Top-down approachThis approach
Page 32 and 33: 9ApplicationGuidanceThis section pr
Page 34 and 35: Discount rates can also be used to
Page 36 and 37: 10GlossaryEntries in the glossary m
Page 38 and 39: Net asset value (NAV)The NAV of a f
Page 40: The ‘Private Equity Fund Risk Mea

Risk Measurement Guidelines - EVCA

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