Performance Perspectives Blog

Security valuation problems: just when you thought you had it figured out

by | Dec 15, 2015

MentalFlossToday’s Wall Street Journal has two front page articles that deal with security valuation problems.

“Investors Abandon Risky Funds” addresses the recent drop in the prices of high yield bonds. We find the following: “Some investors reported difficulties selling lower-rated bonds quickly or at listed prices,…” <emphasis added>

We are seeing here bonds that have list prices which they can’t be sold for. It would therefore call into question the accuracy of these prices.

“In Sale to Saks, Gilt’s Sky-High Value Is Slashed” is about “Internet retailer Gilt Groupe,” which is being sold to Saks, at a price ($250 million) which is roughly a quarter of what it had been valued at in 2011 ($1.1 billion). While private equity securities don’t have markets, there are agreed upon ways to value them. What this story does is call into question the accuracy of these pricing methods, or perhaps the problem with the timing of prices. The most accurate method is to base private equity pricing on recent funding; in this case, it’s the sale that is driving the price, and it’s far from what was expected.

The Global Investment Performance Standards (GIPS(R)) requires fair valuation, and no doubt these examples reflect fair valuation. However, if the liquidity isn’t there, if the demand can’t match the pricing, we can see huge discrepancies in pricing. This was evident in 2008 when many mortgage backed securities were found to be overpriced. We know that private equity assets have challenges, but as the article points out, this isn’t the first time when securities valued at $1 billion or more turned out to be worth much less when sold.

This issue is obviously important to institutional investors, but should also be of interest to retail, who may have some of their assets invested in funds, for example, that hold such securities.

Do security valuation principles need another look?

Whether they do or not, I suspect someone is going to want to understand how these situations arise. Getting security valuation right is not only important to value the entire portfolio, but also for accurate rates of return. No one wants to see the kind of surprises that the investors in these assets found.

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