Valuing illiquid and ‘hard to value’ assets

Abstract

Background: The financial crisis of 2008/2009 focused greater scrutiny on the concepts surrounding the valuation of ‘illiquid’ or ‘hard-to-value’ investment assets. The notion of ‘mark-to-market’ is often misunderstood and misreported in the press. As investors continue to allocate capital to less liquid and hard-to-value assets, it becomes increasingly important to understand what is meant by fair value. Discussion: Fair value, the price that would be received to sell an asset in an orderly transaction between market participants, is the fundamental basis for reporting the value assets at discrete points in time. It is necessary to understand what fair value is, why it is used and how it is estimated. Generally, the value of the equity of a private company is used as the starting point for valuing individual securities. Valuing debt investments may require additional judgment. Other complexities arise when considering the interaction between debt, equity and other instruments in a capital structure. Conclusion: Obtaining timely fair value estimates for illiquid and hard to value assets is critical for investors to exercise their fiduciary duty of monitoring and reporting investments transparently. While judgment is required to estimate fair value, best practices have been established to increase consistency in valuing illiquid assets.