NAV Pricing Methodologies
Definition
Interval fund net asset value (NAV) represents fair value per share calculated daily as: (Total Assets - Total Liabilities) ÷ Outstanding Shares, applying FASB ASC 820 fair value hierarchy: Level 1 assets (30-40% typical)—quoted prices in active markets for identical instruments (publicly traded stocks, bonds, ETFs), marked to closing market prices daily from primary exchanges, no valuation judgment required. Level 2 assets (10-20% typical)—observable market inputs for similar instruments (private loans with recent BWIC transactions, corporate bonds with dealer quotes, derivatives with model-based prices using observable rates/spreads), marked using recent comparable transactions or broker quotations, minimal subjectivity. Level 3 assets (40-60% typical)—unobservable inputs requiring significant judgment (private equity using discounted cash flow models, real estate requiring appraisals, venture capital at adjusted cost or recent funding round valuations, distressed debt with no market activity), valued quarterly or semi-annually using: third-party appraisals (independent valuation firms), internal models (DCF with management assumptions on growth, margins, discount rates), adjusted cost (purchase price modified for subsequent developments), market approach (comparable company multiples, precedent transactions). Pricing frequency: Daily NAV calculated incorporating most recent available values (fresh liquid marks, stale illiquid marks between quarterly updates), tender pricing NAV calculated 2-5 business days after tender deadline using valuations as of that specific date. Third-party oversight: Board of trustees establishes valuation committee (3-5 independent directors) meeting quarterly to: review and approve valuation methodologies for each asset class, examine significant NAV changes (>5% monthly unexplained movements), oversee independent valuation agents (engage specialized firms valuing 10-30% of Level 3 assets quarterly on rotating basis), resolve valuation disputes between manager and third-party appraisers.
Why it matters
NAV pricing methodology determines whether interval fund share prices reflect true economic value or incorporate stale/manipulated valuations. Critical implications: (1) Level 3 asset concentration creates valuation subjectivity—fund holding 60% private loans reported at par (100 cents on dollar) based on internal models may trade secondary market 10-20% discount suggesting market believes true value 80-90 cents, investors tendering at reported NAV potentially overpaying versus economic reality, remaining shareholders harmed if exiting shareholders receive inflated prices, (2) Pricing lag differential advantages informed investors—liquid portfolio components (public bonds, listed stocks) reflect current market prices, illiquid components (private loans, real estate, PE) reflect 1-3 month old valuations, creates opportunity for arbitrage: sophisticated investors tender when recent market movements suggest private holdings overvalued (credit spreads widened 100-200bps but private loan marks unchanged), slow-moving investors remain exposed to eventual markdown, (3) Board oversight quality varies dramatically—rigorous funds employ: multiple independent valuation agents rotating quarterly coverage, mark-to-model comparisons against subsequent transaction prices (validating model accuracy), sensitivity analysis showing NAV range under different assumptions (discount rate +/-100bps creating +/-5-10% valuation range), weak funds rubber-stamp manager valuations without independent verification creating manipulation risk. Real examples: Private credit interval funds (Stone Ridge, Cliffwater) suspended tenders March 2020 citing inability to fairly value loans—no observable transaction prices (BWIC market frozen), broker quotes stale (dealers not providing marks), model inputs uncertain (default probability, recovery rates spiking). Highlighted reliance on market liquidity for pricing—when markets close, fair value determination impossible despite holdings technically performing. Post-crisis analysis showed funds using aggressive assumptions (low default rates, high recovery values) reported NAVs 5-15% higher than funds using conservative assumptions for identical loan types—valuation methodology choice material to investor outcomes. Understanding NAV methodologies critical for: Investors evaluating reported returns (high Sharpe ratios from stable NAVs may reflect stale pricing not true risk-adjusted performance), advisors conducting due diligence (request valuation policy documents, third-party engagement letters, historical NAV versus secondary market pricing comparisons), and platforms selecting funds (preference for conservative valuation practices, frequent independent appraisals, transparent methodology disclosure).
Common misconceptions
- •Daily NAV doesn't mean daily pricing—interval funds calculate NAV daily but illiquid holdings (60-70% of portfolio) updated quarterly. Daily NAV primarily reflects liquid sleeve movements, creates false precision suggesting more frequent marking than reality. Compare to private equity funds honestly reporting quarterly valuations.
- •Independent valuations aren't fully independent—third-party agents hired by fund manager (not investors), rely partially on manager-provided data (financial statements, operating metrics, strategic plans), face incentive to maintain relationship (future business) creating subtle bias toward manager-favorable valuations. True independence requires investor-selected appraisers or regulatory mandate.
- •Board approval doesn't guarantee accuracy—trustees typically lack specialized valuation expertise (real estate appraisal, private credit modeling, venture capital comparables), rely heavily on manager representations and third-party reports, approve methodologies in concept not individual pricing decisions. Boards provide governance oversight not valuation verification. Material misstatements often undetected until crisis forces transparent pricing.
Technical details
Fair value hierarchy and asset classification
Level 1 classification criteria: Active market definition: Principal market where asset normally trades with sufficient volume/frequency establishing reliable prices. Exchange-traded securities (stocks, bonds, ETFs listed on NYSE, NASDAQ, OTC) qualify automatically. Quoted prices: Unadjusted closing prices from primary exchange as of measurement date (4pm ET for US securities). No valuation models or adjustments permitted—pure market price. Interval fund typical Level 1 holdings: Large-cap stocks (S&P 500, international developed markets), investment-grade corporate bonds (liquid names with daily trading), government securities (Treasuries, agencies), ETFs and mutual funds (daily NAV). Percentage: 20-40% of portfolio depending on strategy.
Level 2 classification and inputs: Observable inputs include: Recent trades (identical/similar securities transacting within past 30 days at known prices), broker quotes (dealer providing executable bids/offers for specific position size), yield curves (benchmark rates plus credit spreads observable in market), volatility surfaces (implied volatility from options markets). Common Level 2 holdings: Below-investment-grade bonds with dealer quotes (high-yield corporate, leveraged loans), private loans with recent BWIC activity (comparable facilities trading 90-95 cents establishing range), Interest rate/credit derivatives (swaps, CDS valued using observable forward curves). Percentage: 10-30% of portfolio, bridges liquid and illiquid.
Level 3 characteristics and challenges: Unobservable inputs requiring judgment: Discount rates (WACC, required returns based on comparable company analysis or internal models), growth assumptions (revenue CAGR, margin expansion estimates from management projections), terminal values (exit multiples, perpetuity growth rates), probability-weighted scenarios (weighting restructuring versus liquidation outcomes). Common Level 3 holdings: Private equity (portfolio company stakes valued via DCF or multiples), private real estate (properties appraised using income/sales comparison approaches), venture capital investments (recent funding rounds, adjusted cost, write-downs for distress), distressed/defaulted securities (recovery analysis, restructuring scenarios). Percentage: 40-70% of portfolio concentrated in illiquid alternative strategies. Challenge: Two funds holding identical assets could report 10-20% different values using reasonable but different assumptions (discount rate 12% vs 15% creates material valuation difference).
Valuation methodologies by asset class
Private credit loan valuation: Performing loans (current on payments, no credit issues): Market approach—comparable BWIC transactions (recent loan sales in secondary market establish pricing benchmarks), dealer quotes (broker-dealers providing non-binding indications of value). Income approach—discounted cash flow using contractual interest payments, expected maturity, discount rate reflecting current credit spreads for similar risk. Typical range: Par -3% to +2% (97-102 cents on dollar) for performing loans in stable markets. Impaired loans (missed payments, covenant violations, financial stress): Probability-weighted scenarios—restructuring outcome (extended maturity, reduced interest, partial principal forgiveness), liquidation outcome (collateral sale value less costs). Recovery analysis—enterprise value approach (valuing borrower as going concern), liquidation value (asset-by-asset appraisal of collateral). Typical range: 40-80 cents on dollar depending on severity and collateral quality.
Real estate valuation approaches: Income approach (most common for commercial): NOI projection (stabilized net operating income based on current occupancy, market rents, operating expenses), cap rate application (discount rate reflecting property type, location, quality, market conditions), DCF variation (multi-year cash flow projections discounted to present value for development/renovation properties). Sales comparison approach: Comparable property sales (recent transactions of similar properties in same market), price per square foot or per unit adjustments (normalize for size, age, condition differences), market conditions overlay (trending cap rates, supply/demand dynamics). Cost approach (backup method): Replacement cost (land value plus cost to rebuild improvements), depreciation adjustments (physical deterioration, functional obsolescence, economic obsolescence). Appraisal frequency: Quarterly desktop valuations (appraiser updates prior valuation for new information without site visit), annual full appraisals (physical inspection, comprehensive analysis).
Private equity valuation techniques: Public company comparable multiples: Select comparable publicly-traded companies (same industry, similar size, business model), calculate trading multiples (EV/EBITDA, EV/Revenue, P/E), apply median/mean multiple to portfolio company metrics, liquidity discount (15-30% for lack of marketability versus public securities). Precedent transaction multiples: Recent M&A transactions for comparable companies, transaction multiples paid (EV/EBITDA typically), apply to portfolio company with adjustments (strategic premium, market conditions). Discounted cash flow: Management projections (5-year revenue, EBITDA, capex, working capital), terminal value (exit multiple or perpetuity growth), discount rate (WACC or required IRR 12-20% typical), sensitivity analysis (base, upside, downside scenarios). Valuation triggers: Quarterly marks incorporating: new financial results, change in business prospects, comparable company movement (if public peers down 20%, private valuation should reflect), industry multiples compression/expansion.
Third-party oversight and governance
Independent valuation agent engagement: Scope and coverage: Typical engagement—value 10-30% of Level 3 assets each quarter (rotating selection ensuring full portfolio coverage annually). High-risk assets (distressed positions, significant markdowns, manager-appraised outliers) receive priority. Services provided: Fair value opinions (formal written valuation reports), methodology review (assessing appropriateness of manager's approach), reasonableness testing (comparing manager marks to independent analysis), market data (providing transaction comps, industry multiples). Cost: $50K-$500K+ annually depending on portfolio complexity and coverage percentage.
Valuation agent selection and independence: Procurement: Manager typically selects and pays valuation agent (creates potential conflict), better practice—investor committee or board independently hires (rare in interval funds). Qualifications: Specialized valuation firms (Duff & Phelps, Houlihan Lokey, Lincoln International) with industry expertise (private credit, real estate, PE/VC sectors), credentials (ASA, CFA designations), relevant experience (prior interval fund or private equity work). Rotation policy: Some funds rotate agents every 3-5 years preventing over-familiarity, others maintain long-term relationships for consistency, best practice—rotate coverage (different assets each quarter) while maintaining primary relationship.
Board valuation committee structure: Membership: 3-5 independent trustees (non-affiliated with manager), financial expertise requirement (SEC qualified as audit committee financial expert), specialized knowledge preferred (prior valuation experience, accounting background, industry expertise). Responsibilities: Approve valuation policies and procedures, review quarterly valuations (all Level 3 assets, significant changes, red flags), oversee third-party agents (approve engagements, review deliverables, resolve disagreements), investigate valuation complaints, approve NAV used for tenders. Meeting frequency: Quarterly minimum (align with valuation cycles), ad hoc as needed (significant events, tender pricing, disputes).
Valuation dispute resolution: Manager versus third-party disagreements: Typical: Third-party values asset 10-15% below manager's mark (not uncommon given assumption differences). Process: Manager presents supporting analysis, third-party explains rationale, committee evaluates both positions. Resolution: Committee selects value (manager, third-party, or midpoint), documented in minutes with reasoning. Material disputes (>20% variance): May require additional independent appraisal (hiring second valuation firm to arbitrate), potential legal consultation (fiduciary duties in selecting value). Shareholder challenges: Rare but increasing—shareholders alleging inflated NAV harming remaining investors. Burden of proof on challenging shareholder (must demonstrate valuation not in good faith), funds typically prevail if followed documented policies.
NAV calculation mechanics and adjustments
Daily NAV calculation process: Cut-off time: 4pm ET—trades executed, market prices captured, expense accruals updated. Asset valuation: Level 1—closing market prices from exchanges or pricing vendors (Bloomberg, ICE Data Services). Level 2—broker quotes or model prices using day's observable inputs (yield curves, spreads). Level 3—most recent quarterly/semi-annual valuations (updated only if material event). Liability calculation: Accrued expenses (management fees, operating costs, legal/audit through calculation date), payables (fund expenses not yet paid, pending trades), borrowings (credit facility draws, margin loans if applicable). Share count: Outstanding shares adjusted for subscriptions/redemptions settling on calculation date, potential dilution from convertibles or warrants. Formula: (Assets - Liabilities) ÷ Shares = NAV per share.
Expense accruals and timing: Management fees: Accrue daily based on average daily NAV (annual fee ÷ 365 days). Example: 1.5% annual fee, $100M NAV = $4,110 daily accrual. Operating expenses: Estimate based on prior periods, adjusted quarterly for actual costs (legal $50K quarterly, audit $200K annually, pricing $100K annually). True-up quarterly—over-accruals refunded to NAV, under-accruals charged. Performance fees: Accrue only if fund has performance fee (rare in interval funds), based on realized and unrealized gains. Complex calculation involving high-water marks and crystallization.
Share class NAV allocation: Multi-class structure: Class A (retail with load), Class C (retail no-load), Class I (institutional), each with different fee structures. Separate NAV calculation: Proportional asset allocation (each class owns percentage of total portfolio), class-specific expense allocation (12b-1 fees only charged to applicable classes, administrative costs allocated pro-rata). Class A NAV example: $100M total portfolio, Class A 40% = $40M allocation. Less Class A expenses (0.25% 12b-1 = $100K annually) = $39.9M. Divided by Class A shares outstanding = Class A NAV per share (lower than Class I by fee differential).
NAV adjustments and restatements: Correction triggers: Pricing errors (vendor providing wrong closing price, manual entry mistakes), valuation methodology changes (switching from one model to another requiring NAV revision), omitted expenses (audit/legal bills not accrued properly), theft/fraud (missing assets requiring write-down). Materiality threshold: SEC guidance—restate if error >0.50% of NAV (50 basis points). Example: $100M fund, $600K error exceeds $500K threshold, requires restatement. Smaller errors corrected prospectively (charged to current period NAV, not historical correction). Restatement process: Board approves correction, amend prior financial statements and shareholder reports, notify shareholders of correction (if material), investigation into root cause and controls.