Why NAV reporting is a strategic exercise beyond numbers

Net Asset Value (NAV) reporting has evolved from a mere procedural task to a strategic tool within funds and family offices.

In brief

• International guidelines and best practices are progressively advocating for the adoption of fair value reporting.
• Robust valuation and model validation are key for precise asset assessment.
• The role of an independent expert is crucial for best practice governance, avoiding conflicts and boosting regulator and investor confidence.

NAV reporting provides a comprehensive picture of a fund’s financial status and delivers key insights into the investee companies’ financial and non-financial performance. This information has become increasingly important for all fund’s stakeholders, extending beyond just the fund investors or limited partners. Current best practice NAV reporting utilizes fair value principles. Fair value reflects the current market conditions, providing a realistic assessment of the fund’s holdings.
 

The importance of NAV reporting

By using fair value as a standard measure, NAV reporting ensures that the reported values are timely, relevant, and aligned with the market’s perception of the asset’s worth, thereby enabling stakeholders to make informed decisions based on the most accurate and up-to-date information available.

In addition, regulations, such as the Alternative Investment Fund Managers Directive of 2011 (AIFMD), have emphasized the importance of NAV reporting, including the “proper and independent valuation of the assets of the Alternative Investment Fund (AIF) […] ensuring that the valuation function is performed impartially and with all due skill, care, and diligence”. The same ideas and principles are advocated by other norms and standards worldwide, such as the International Valuation Standards (IVS), the Fair Value Measurement Standards (ASC 820), and the Valuation Guidance from the SEC and PCAOB, among others.

Besides, the heightened market volatility in the last couple of years and the apparent ‘smoothening’ of private equity assets have further increased the scrutiny by regulators and investors on valuation practices – also reinforced by the growing share of private assets in the economy.

Together, these factors have warranted alternative investment funds to produce detailed valuation policies and procedures for each asset they own, along with proper governance models.

The practice of reporting at fair value, even if not mandated by local accounting standards, is increasingly encouraged by international guidelines and best practices. It better satisfies the needs of both fund managers and investors, promotes resilience in changing market conditions, and increases valuation consistency and comparability between funds. Since accurate and continuous NAV reporting is a commitment to enabling investors to make better economic decisions, any lack of accuracy and fairness in valuation could significantly damage a fund’s credibility.

We see several iterative steps in setting up an effective NAV reporting: defining the procedures and governances, which includes selecting appropriate guidelines, collecting financial data for valuation purpose, setting up a robust valuation framework ensuring the right degree of independence and transparency, and, finally, reporting and communication the output. (as summarized in the graph below).

This article highlights several topics within this process beyond traditional value reporting that can empower various stakeholders to make improved decisions.
 

The selection of financial and accounting guidelines

NAV reporting starts with the selection of appropriate accounting and valuation guidelines. These guidelines – or their interpretation thereof – are typically documented in an internal governance document, i.e. a valuation charter, setting out the organization’s standards and methodologies for asset valuation, providing clarity to all employees involved in this process. It eliminates ambiguity and establishes a uniform standard within the organization. Options range from internationally acknowledged financial reporting standards IFRS, over industry guidelines (such as IPEV and IVSC) to local GAAP. The choice for a standard based on a fair value principle is highly recommended. It is crucial to ensure that these guidelines or policies are comprehensive, addressing a spectrum of situations to preclude potential future discussions on valuation approaches.

Mapping the different investments according to maturity, industry, risk, and other factors is a key step. Assigning a particular valuation method to each investment category and ensuring that exceptions to a rule are covered is also essential. These guidelines are designed to achieve consistency in asset valuation over time and across different assets. To be effective, the policy should stand the test of time and be reviewed and approved by the relevant parties.
 

Performing the valuation and periodical review

Transparent and rigorous valuation methodologies are essential for the accurate assessment of assets. When employing models, they need thorough validation to ensure reliability. While the fund manager is ultimately responsible for valuing assets, certain asset classes may require specialized external valuers due to their complexity. These experts can provide an objective view and technical expertise, ensuring that valuations are conducted in accordance with industry standards and remain free from biases. Using external valuers not only enhances the credibility but can also help fund managers navigate the complexities of the regulatory landscape and meet stakeholders’ expectations.

Valuations and reviews should be conducted consistently and regularly, depending on factors such as fund size, the variety of asset classes, and the applicable regulatory requirements. More frequent measurements can improve accuracy and decision-making, albeit at the risk of imposing additional strain on resources. However, automation and technology can make frequent valuations easier without overburdening the organization.

The IPEV guidelines introduce the following concepts as best practice when performing the valuation and reviewing periodically: