Page 96 - Annual Report 2010

ANNUAL REPORT 2010

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3.5.3.3. Market risk: other price risk

Other price risk is the risk that the fair value of the financial instrument will fluctuate as a result of changes in market prices (other than those arising from interest rate risk or currency risk), whether caused by factors specific to an individual investment, its issuer or factors affecting all in-struments traded in the markets.

3.5.3.3.A. Private Equity

The specific characteristics of the PE asset class make it difficult to apply traditional approaches to risk analysis. Market r isk analys is requi res an est imat ion of the correlation between the asset class assessed and the changes in market risks other than those arising from interest rate risk or currency risk. This can be done based on the capital asset pricing model. This model uses the beta, i.e. a measure of risk relative to the market, which is estimated by regressing returns on an asset against a public market index.

While public market managers can rely on reliable statistical data to suppor t their analysis, such data is lacking for PE and in particular Venture Capital. Analysis of PE returns, volatility and correlations is limited by the

Public market risk: all private equity

+10% -10% Retained Beta 1.3 Retained Beta 1.3 Final Sensitivity: +13% Final Sensitivity: -13%

Profit & loss account

Equity (Fair value reserve)

Total effect on equity

Profit & loss account

Equity (Fair value reserve)

Total effect on equity

31.12.2010 378 829 22 363 253 22 742 082 (14 592 133) (8 129 976) (22 722 110) 31.12.2009 270 701 20 274 657 20 545 358 (6 105 450) (15 569 320) (21 674 770)

3.5.3.3.B. Portfolio Guarantees and Securitisation

As EIF’s G&S transactions are not actively traded on public markets, direct sensitivity to price risk is not a consideration.

relatively short time series of the publicly available data, which is not fully representative of the market. In particular, data does not fully capture the uncertainty of the asset class. Furthermore, as the IRR, the standard performance measure used for PE funds, is capital-weighted, while for public market assets it is traditionally time-weighted, it is not possible to analyse the correlation between PE and other asset classes without significant adjustments and therefore potentially large biases.

The EIF uses a beta derived from the betas of three listed PE indices, LPX Europe Price Index, LPX Venture Price In-dex and LPX Buyout Price Index, to estimate the sensitivity of the valuation of EIF’s PE investment to market prices. Regression has been carried out using the Dow Jones Euro Stoxx 50 over the last two years.

Using the most conservative beta from the three indices mentioned above and assuming market price movements of ±10%, the final sensitivity (i.e beta x ±10%) is applied to the net asset value to give an adjusted net asset value, which is then compared to the net paid in. The calculated value adjustment is then recorded using the methodology described in note 3.2.1. EIF’s PE investment value would be impacted as follows: