Monday, November 19, 2012

What is NAV (Net Asset Value)?

NAV, or Net Asset Value is typically a term used in investment funds (both listed and unlisted).  It is the assessed value of the funds assets, normally by the management of the company and approved by independent valuers (though not always).

NAV is also sometimes referred to as NTA, or net tangible assets however I think this term is incorrectly used as NTA is used for all types of companies and does not necessarily refer to this independent valuation of assets process

What types of entities disclose NAV?

NAV is typically disclosed where it is hard for investors to see or discern the value of the assets.  This is often used for investments where the exact composition of the portfolio is unknown or where the assets are inherently illiquid and so assessing an actual value from regular valuation methods becomes difficult for investors.

There are many types of entities that disclose NAV however some of the most common ones are:

  • Property trusts (both listed and unlisted)
    • Property of all types is inherently illiquid.  As investors we know that the value of properties are changing however without the full information about all the properties held in the trust it is pretty hard to know how the valuation of these trusts are moving year to year
    • Property trusts normally revalue their assets on an annual (or sometimes semi annual basis) so that investors know what the theoretical value of the assets within the trust are worth
  • Equity funds
    • Equity funds normally disclose their NAV on a daily basis.  It is very easy for them to calculate however very hard for outside investors to work out because they do not know the exact composition of the portfolio
    • For equity funds the NAV represents the valuation of all the shares within the fund (and you divide this by the number of units to get the per unit NAV
  • Infrastructure funds
    • Infrastructure funds also typically disclose a NAV for the same reasons as property trusts
    • They typically hold more than one asset and investors find it hard to value these assets from an external perspective.
  • Companies with minority stakes in several unlisted assets
    • Where a company does not have a controlling shareholding in several assets they often disclose NAV because it is almost impossible from regulatory filings and presentations to work out what these assets are worth
  • Externally managed vehicles
    • I have written before on the corporate governance related to externally managed vehicles
    • External managers are often compensated based on the value of the assets under management. In order for investors to understand the fees being paid to external managers they often provide a valuation of the company and it's assets to justify the fees.
Why do companies trade at a discount or premium to NAV?

For listed funds and companies you will notice that they very rarely trade at NAV (the exception to this is listed equity funds which never really deviate far from NAV).  This seems counter intuitive - if you know the value of the assets then why would you see for less than they are worth and conversely why would you buy for more than they are worth?

The answer is quite simple - the NAV is always a point in time estimate and not representative of the valuation of the entity after this time.  If investors believe that the value of the NAV has moved since it was published they may pay less or more depending on whether they think the value of the entity has gone down or up.  For example in a soft property market no one is going to trust a NAV published 9 months prior.

Also investors often do not trust the NAV itself.  The fact is that the NAV is based on someone valuing the entity and they may be right or they may be wrong.  There are many companies who's valuations are always higher than what the market thinks and these constantly trade at different values to NAV.  The NAV is always based on a set of underlying assumptions and if you flex some of these assumptions you can come to very different valuations.

Should I buy if the fund or company is trading at a lower value than NAV?

The answer to this is - it depends.  If you trust the NAV then absolutely however you always need to critically think about the NAV.  Things you need to think about include
  1. Why do you think the market does not like the valuation of this stock or fund - do they know something you don't?
  2. How much 'fat' do you have in this discount.  A 50% discount to NAV is a lot safer than a 5% discount if you are not really sure about how fair the NAV is
The fact that an entity is trading at a discount to NAV (even if it is a steep discount) is not an automatic reason to buy.  You need to go through the same evaluation process you would with any other stock before making that decision.  Never trust someone else's valuation - you can use it to inform your decision but it should never be the basis of it!

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