There has been a flurry of recent research documenting the outperformance of private equity versus other asset classes and, in particular, listed equities. But rather than proving reassuring, this actually seems to have generated even more scepticism about the industry.
Benchmarks play a crucial role in financial markets when it comes to asset pricing, and not just by providing the comfort of clear comparisons. If benchmarks are incorrect, valuation, pricing and related investment allocation and risk management decisions are affected and potentially impaired.
Little flexibility remains as to how such an indexing environment should be built to suit these requirements. As a rational pricing approach needs to go beyond the level where demand and offer meet, particularly in markets that are not adequately developed and liquid, and allow relative value and risk arbitrage considerations, the only framework that can possibly be adopted is a time-weighted one.
But being innovative within the indices space makes sense only if it improves industry conditions and the investment experience for investors. The primary objective is to introduce a measure that is correct, appropriate and realistic. The critical condition for its adoption is that the new approach must yield useful tools including pricing, synthetic hedging, liquidity, and asset allocation instruments.
Massimiliano Saccone is the founder and managing partner of XTAL Strategies, an emerging leader in the new market of indexed and synthetic solutions that improve price transparency, liquidity, risk management and allocation practices for the investors in private capital funds.