Thursday, October 11, 2012

Valuing securities with stale prices for GIPS compliance

I am preparing to meet with a hedge fund client who wants to comply with GIPS(R) (Global Investment Performance Standards). As part of this preparation I am revisiting the recently published Guidance Statement on Alternative Investment Strategies and Structures.

This guidance makes it clear from the start that what is set forth within it applies to all asset classes.

When the GS was being discussed by the GIPS Executive Committee, I inquired into one particular section:

This essentially gives firms the opportunity to use stale prices, if those prices are deemed "the best estimate of the current fair value of the investment."

I asked (in order to confirm) whether this could be applied to fixed income securities, for example, and was told "yes."

This is a HUGE change. I recall individuals at the annual GIPS, conference around the time the 2010 edition was introduced, asking about the need to revalue for large cash flows, when their portfolio might contain less liquid securities (e.g., municipal bonds) that do not price daily. While I don't recall the specific response, I do not believe it was what is stated here.

If a GIPS compliant manager who has such assets finds that they may need to use historical prices, they need to document this in their valuation policy and indicate that they do so when they believe it's the "best estimate of the current fair value of the investment." Alternatives, such as the use of matrix pricing, can also be used, but it's good to know that firms can also use historical prices.


  1. Let me suggest that the term "stale" prices is potentially misleading. In this context "stale" doesn't mean bad, as though you were applying the word to describe a loaf of day-old bread. I believe a better term could be "last price" or "most recent price." Often this is all we have.

    As you note, many investments are not traded frequently and so there is no observed price for what may be extended periods of time. There may be somewhat dated last observed prices (for some bonds) or obviously outdated last trade prices. For many assets - those that trade infrequently (like real estate) or not at all (like private equity) the only reasonable measure of value is, by definition, an estimate. That's not a wild guess, but rather the result of a rigorous process that was defined in advance and which by definition depends on the credibility of the person assigning the price. Sometimes that person is a broker and other times it's an investment manager.

    A reality of investing is that "It's not over until it's over." The effect of so-called "stale prices" is some short term potential for imprecision regarding interim returns. However, on the sale, maturity or other termination of the investment we have certain valuations, and the long term performance of that investment is known with absolute certainty. We can quibble about the effect this has on short term volatility, but that would be little more than... well, quibbling. So much of the "controversy" in performance and performance regulation tends to be "much ado about nothing." Hopefully, this reasonable guidance on the use of available pricing will help to quell some of this confusion and help to restore some confidence in the performance measurement process.

  2. Thanks, Steve. I'll admit that I hesitated in using the term "stale" for the reasons you cited. And while the interim prices serve a purpose, it's the terminal price that tells the final tale, the concern is when prices have (or should have) moved, but since there are no market prices, the validity of the "last price" may be questionable. This occurred in '08, when some less liquid mortgage backed securities had stale prices, which the market would have suggested were too high, but with no option to use "fair value," firms in some regions (I am thinking Europe) were forced to use what they believed to be invalid prices. This new guidance provides firms some leeway here when they do, in fact, have a belief that the last price is reasonable; the earlier guidance (and comments made at the GIPS conference) would have suggested that these prices could not be easily used. The thinking appears to have changed a bit, which is a good thing.


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