Risk Measurement Guidelines - EVCA

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II. Top-down approachThis approach can be adopted for measuring the risk ofportfolios of co-investments only and entails a generalassessment of portfolio funding, liquidity, market andcapital risks.Risk models for co-investments are generally characterisedby material model risks due to relatively high reliance onsubjective judgment when assessing the impact of morequalitative risk factors (e.g. quality of management, level ofinfluence on board and management decision, etc).8Model Validationand VerificationThe accuracy and robustness of riskmanagement frameworks need to bereassessed regularly.30 I EVCA Risk Measurement Guidelines 2013
I. To be objective and unbiased, the verification andvalidation processes should be conducted independently.This can be done by independent qualified internalstaff or through an external review prior to actualreliance on a model, and periodically thereafter.II. For their risk measurement, limited partners shoulduse several sources to be able to capture all relevantavailable market data. Sensitivity analysis, stresstesting, qualitative assessment and judgment areappropriate ways of overcoming data scarcity andshowing that results are still valid under morepessimistic conditions.III. Knowledge gained from the monitoring of funds has tobe incorporated in risk measurement. Judgment hasto be structured and well documented. Models shouldnot be based on the assumption that the limitedpartner has above-average selection skills.IV. Market indices are important as one modelling inputand as benchmarks for risk measurement but cannotbe a substitute for a risk model that is specific to aninstitutional investor’s portfolio of funds.Risk measurement models should not be static and need tobe improved continuously. They not only have to incorporaterelevant past data but should also evolve with new informationand adapt to a changing environment. Models should beregularly validated and verified. Limited partners need toensure that choices of reference data and scenarios do notassume they have above-average selection skills.Scarcity of data on the universe of private equity funds canbe a major obstacle to precise risk measurement and toback-testing of models. For example, smaller private equityinvestment programmes will have good quality data only ontheir investee funds. Investors in the early stages of buildingup portfolios of private equity funds will face similar issues.In addition, where investors are exposed to venture capitalinvestment in innovation, the past does not always providea reliable yardstick for the future. In situations where thereare significant difficulties in accessing good quality andrepresentative data, assumptions and modelling choices,well documented judgment, stress testing and scenarioanalysis have to play a significant role.Risk models use a variety of indices related to public marketsas well as private equity market-specific ones. The mappingof the overall portfolio on the market indices has to be clearlydefined. The (sub-)indices used to quantify shocks or volatilitymust be representative and consistent with the structure(notably diversification, quality, stage in the funds’ lifecycleand the investor’s funding liquidity test) of the (sub-)portfoliosto be modelled. In the case of private equity market indices,the completeness and quality of the data needs to be takeninto consideration.EVCA Risk Measurement Guidelines 2013 I 31
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 14 and 15: Interest rates and refinancing term
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 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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