Rags to/from Riches

I was reviewing some performance figures at work yesterday. The stock market here has been absolutely on fire non-stop since May, and the company’s funds are outperforming both the market and peer groups. Really phenomenal job they’re doing on both the fixed income and equity side.

Then I took a look at the net asset value, or NAV, charts. It resembled the EKG readout of someone in the throes of a lurching, painful heart attack – sharp drops and peaks all over the chart. What causes fluctuations in this kind of statistic? First, the NAV will fluctuate naturally with, well, the value of the assets. Second, NAV per share can change based on the number of shares of the fund outstanding. Lastly, fluctuations in NAV can be a result of capital gains disbursements.

So, I started looking into what was going on with some of the funds. Had there been large capital gains disbursements? The reaction I got leads me to believe that gains aren’t disbursed here the same way. Also, the peaks and drops were way too frequent and irregularly dispersed. So that’s out. Have there been massive redemptions and offsetting huge sales that have affected the share base? No, not that either.

It’s way more basic. It’s the value of the assets themselves.

Russian law dictates that a fund compute its NAV using an average of the closing market prices over the 10 days prior to the point of measurement. In US accounting terms we’d call it “mark- to- market” valuation.

The wrinkle in the Russian rule is that there must be a data point for each of those 10 days. Now, in a largely illiquid market like this one, it’s pretty common to not have daily quotes on a good number of things in your portfolio. All those stocks with gaps in the 10 day trading history have to be valued not at what they’re worth, but at what you paid for them. In short, and again in US parlance, at historical cost. In a stock market that’s been going gang busters all year (and was the best performing international market last year), it’s pretty easy to be sitting on some sizeable gains in relatively illiquid stocks.

Instead of Kalina at $33, for example, you’re looking at valuing the position at about $2 share. Big difference.

What can you do about this? One trick is to do a little churning in the portfolio in the days before NAV measurement. If it gets late in the day and you notice that something hasn’t traded yet and failure to do so will break a string of market prints up to your 10 day mark, you get on the phone and sell a couple of shares to a buddy across town. Just to get a value on the tape. Of course, you’ll probably have to buy a few shares of something from him. Some firms have more than one equity fund for exactly this kind of reason. Sell shares to yourself so that you can fulfill the requirement of figuring out how much they are worth!

It beats the alternative – not knowing how much money you really have.