The first half of 2022 has seen major shocks to the economic environment and investment markets. Interest rates rising at record breaking pace driven soaring inflation have triggered steep declines in growth assets including tech stocks and listed property as investors discount potential future earnings at higher discount rates.
Unit pricing purpose and principles
The purpose of unit pricing is to correctly attribute the value of a pool of investments to investors.
The key objective is to equitably and consistently distribute investment returns to investors. At all times, and especially when the investment market is so volatile, it is best practice to come back to the underlying first principles and apply these as your framework to the unit pricing situation at hand. The most critical of the unit pricing principles we at McGing apply, are:
1. Proper Financial Position
Investors receive the appropriate value for their investments at all times. Practical constraints and considerations need to be recognised.
The unit pricing methodology delivers equitable value attribution to all investors. Equity should also be maintained between active and exited investors.
3. Reflect Unit Pricing Basis
The unit pricing basis, as disclosed in the relevant PDSs or Information Memorandum and any other relevant governance requirements, is adhered to.
4. Consistency with External Industry and Regulatory Guidance
Unit price calculations should be carried out in accordance with relevant industry and regulatory standards and guidelines on unit pricing including APRA/ASIC RG94.
5. Best Estimate at the Time
This principle explicitly underlies much discussion in the RG94 Guide: ‘The calculation of each element of the unit price should be the “best estimate calculation at the time”’.
6. Simplicity and Robustness
The unit pricing process needs to be robust and capable of withstanding stressful conditions, such as market movements of 20% or 30% in a day.
Application today – in volatile times
The risk of errors in unit pricing increases markedly when people are under time pressure. An error is more likely to be material and damaging at a time of large changes in asset value and unit price.
There are more result exceptions and threshold breaches to be checked when markets move significantly quickly. Reasonableness checks on changes in unit price take more time, and delays arise from asset valuations or feeder fund prices taking longer to come in.
Listed asset buy/sell spreads may be wider as the balance of willing buyers and willing sellers tilts.
Liquidity may be diminished limiting transactions and reducing price margin.
The big question is how to fairly determine the value of unlisted assets and to what extent should they reflect the underlying causes of similar listed asset price changes?
As losses mount the value of any deferred tax assets and a cap thereon incorporated in the unit price needs to be reconsidered. They may not be fully realisable.
What to do
Be in a constant state of readiness for these markets.
- Review your policy, process and procedures especially the controls in place to mitigate the risk of errors.
- Understand the financial, process and human elements.
- Have well documented policies and procedures in place with active maintenance through training and periodical checks to make sure they are deeply understood and practiced as defined.
- Check your asset valuation and unit pricing calculation methodologies are robust and stable to still meet the definition of best estimate of unit price.
For unlisted assets, have a documented policy on how to estimate a best estimate value between standard valuation dates, for both normal market and extreme market movements. Consider “short cut valuation adjustment” methods using readily available market information to enable rapid re-action in calculating best estimate value, so that is a fair reflection of changes in the underlying asset values to both investors transacting in and out of such funds.
Markets crash and recover all the time!
- Regular sound assessment and review of your unit pricing processes, with board approved policies
- Processes and procedures with controls updated to reflect findings and then tightly managed and monitored
will help you sleep at night with a clear conscience.