IV Indicator Post-Tariff Update

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After our report on the impact of the April 2 “Liberation Day” tariff announcement, we’ve received several requests for more information concerning our view of intrinsic value (or “IV”). We thought we’d use this as an opportunity to educate you and provide a quick update on where we believe IVs stand today, after about one month since the announcement.

First, a quick summary of our methodology. Observed net asset values (NAVs) are noisy, smoothed, and biased signals of actual fair values, or IVs. At the aggregate market level, changes in IVs (adjusted for interim cash flows) should reflect largely systematic market beta, which we model using levered, industry-adjusted, small-cap public equity. But we don’t observe IVs—we just observe NAVs. NAVs have several persistent properties driven by well-studied, persistent investor behavior, including smoothing and conservativism for performing positions relative to future exit values. Using these well motivated assumptions, we can build an estimate of IV using just the observed pattern of Buyout activity. We complete the model by assuming that IV and NAV must converge over the long-run, even if they may deviate substantially in the short-run. The result is the Arctos IV indicator.

As of this writing (April 30), our IV model estimates that IV as a percentage of December 31, 2024 NAV for North American Buyout is at 80% (Figure 1). This is a modest improvement from our tariff piece, due to slight recovery in public markets and lower denominator for Q4 NAV (0.8% QoQ, vs. 1.9% prior Nowcast). Nonetheless, this level is still substantially below prior year levels, especially relative to late 2024 after the post-election rally.

The value of our IV indicator is this: at low IVs relative to NAVs, we should expect a difficult exit environment (all else equal), since GPs are loath to exit positions at a markdown to NAV. If the average position is overvalued, this will clearly weigh on exit volume. One can think of IV as the “rational bid” and NAV as the “conservative ask”—for a sale to occur, the bid must be above the ask, and ideally well above.

Optimism for deal activity in 2025 was apparent from public share prices; however, we believe that such optimism was not warranted, due to underappreciated structural shifts in the private equity exit market. Another factor was our IV indicator: even at the height of the post-election trade, IVs sat at 95-100 cents—still not enough to warrant a flurry of deal activity.

As of December 31, 2024, distribution yield (distributions / NAV for North American Buyout) came in at a continued low level at 3.3%. Seasonally adjusted and smoothed slightly to reduce noise, Q4 2024 was even lower at 2.8% (Figure 2). (Q4 distribution yields tend to be higher than average.) On top of the structural shifts mentioned above, we are now facing reversal of the cycle, from a tailwind to an added headwind. We plan to publish our Q2 Nowcasts shortly, which we expect will reflect this shift.

Finally, it is worth noting the implications of this sudden decline in IVs on the traditional secondaries market. According to Jefferies, average LP portfolio pricing for Buyout funds was approximately 94% of record date NAV (typically 2-3 quarters prior) in 2024. On average during 2024, we estimate IVs to have been 89% of two-quarter trailing NAV; for secondary buyers to generate enough gross alpha to repay their fees and carry, they would have had to purchase Buyout portfolios at 80%—far below the 94% actually paid (Figure 3). (We call this 80% figure the “Net Alpha Neutral Pricing”, as shown in Figure 3.) This chronic overvaluation in the private equity secondaries market has persisted since 2022, resulting in historically low net alphas for secondary purchases.

The rapid drawdown in IVs since April 2 only exacerbates this disconnect—now, secondary buyers would need to buy at less than 72% of NAV, and likely much lower, given that distribution headwinds should persist that will lengthen secondary deal durations. In our view, it is highly unlikely that actual secondaries pricing will revert to this level, and in keeping with the last three years, we remain in an excellent period to be a seller in traditional secondary markets.

What’s occurring today in the PE secondary market holds lessons for all private markets investors. On average, over the long-term, LP portfolios were bought at roughly a price that would deliver reasonable private equity beta to LPs, net of fees, with a mitigated J-curve, faster return-of-capital, and generally low loss ratios. Sometimes it was lower, like from 2009 to 2016, but this was more than offset by improving asset fundamentals and an accelerating, healthy distribution environment. Put simply, one should expect secondary market buyers to slightly overpay when the future is bright. But as of 2022, something new is occurring—the future for asset growth, returns, and distributions remains clouded at best, and we’re seeing record overpaying for exposure. To us, this is suggestive of rapid capital accumulation, and inelastic demand for new origination, which is consistent with the robust growth trajectory for secondary market fundraising over the last few years. Until this story changes, we do not see what could cause this pricing disconnect to close.

This material is provided by Arctos Partners, LP solely for informational purposes and is provided as of the date indicated above. Arctos Partners is not providing or undertaking to provide any financial, economic, legal, accounting, tax or other advice or recommendation in or by virtue of this material. The information, statements, comments, views, and opinions provided in this material are general in nature and (i) are not intended to be and should not be construed as the provision of investment advice by Arctos Partners, (ii) do not constitute and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action, and (iii) may not be current. Arctos Partners does not make any representation or warranty as to the accuracy or completeness of any of the information, statements, comments, views or opinions contained in this material, and any liability therefor (including in respect of direct, indirect or consequential loss or damage of any kind whatsoever) is expressly disclaimed. Arctos Partners does not undertake any obligation whatsoever to provide any form of update, amendment, change or correction to any of the information, statements, comments, views, or opinions set forth in this material.