In the context of investment funds, The Net Asset Value (NAV) is a single number that synthesizes the performance of the fund, defining the price at which the fund units can be subscribed to or redeemed. Its value is key for investors to make informed decisions, and as such, it needs to be calculated and reported in a meticulous way.
This article dives into how the NAV for open-ended investment funds is calculated. It covers both the traditional methodology and the benefits that using blockchain technology and the Fume software brings to it, enhancing transparency and correctness.
The NAV is the fundamental metric of an investment fund and is used for multiple purposes:
When subscribing capital to a fund the investor receives shares of the fund, i.e. fund units, and the NAV is simply the normalized value per share.
In open-ended funds it is usually calculated and reported on a regular basis, on a daily, weekly, monthly, quarterly, or yearly basis, giving the investor a snapshot of what each share is worth at a specific moment in time.
One single value to synthesize the whole situation of a potentially very complex investment strategy is quite a compression of information, so how is it calculated?
The formula to compute the NAV is the fund's total gross asset value, divided by the number of shares outstanding.
NAV = Gross Asset Value / Number of Shares Outstanding
The formula in itself is simple, but a certain amount of complexity resides in its two components.
The Gross Assets Value (GAV) of a fund is the difference between the total assets and the total liabilities held by the fund.
GAV = Total Assets - Total Liabilities
Mentioning assets and liabilities typically brings to mind a balance sheet. In fact, the action performed to compute the GAV is the establishment of detailed accounting and the consolidation in the traditional financial statements, where the total assets and the total liabilities can be found.
Different accounting standards can be used to consolidate the accounts, and the chosen one is often defined in the offering memorandum of the fund. For example, in Luxembourg, the accounting standard used is named Lux GAAP.
Keeping track of the total number of shares outstanding may appear simple but requires making adjustments to treat all investors fairly. Three distinct events lead to a variation in the number of shares in circulation:
When a new investor desires to subscribe to the fund, new fund units need to be issued. The amount of fund units issued is calculated by dividing the subscribed capital minus the entry fees by the last NAV available. At the inception of the fund, when no prior NAV is available, a standard value is used (e.g. 100 or 1’000).
Number of new shares issued = (subscribed capital - entry fees) / NAV
The issuance of the new fund units is generally performed immediately after the calculation of the NAV and therefore requires the subscribed capital to already be available to the fund.
When an investor wishes to redeem its fund units, the capital to redeem is calculated by multiplying the NAV by the number of fund units minus the exit fee. Such units are then removed from the fund’s share registrar.
The most complex case appears when the fund applies a performance fee with a high-water mark, and investors with different high-water marks are present.
When the fund incurs performance, it is essential that the performance fee extraction impacts all investors fairly.
A common solution is to perform an equalization before the calculation of the NAV. This is achieved by adjusting the number of shares of each investor that is above the high-water mark. The result can be obtained in two ways:
The following procedure applies if option II. is chosen:
NAV*.shares * (1 - (NAV - (NAV* - HWM) * perf_fee_rate) / NAV*)
Where shares is the amount of shares the investor currently owns, HWM is the high-water mark of the investor, and perf_fee_rate is the percentage of the performance fee.
The calculations described above involve multiplication and divisions between large numbers, inevitably generating values with a long number of decimal digits. Often, values are rounded to represent tangible values in the accounts, and in order to balance all accounts in an exact way, small liabilities in favor of investors are introduced.
It is worth noticing that upon subscription the investor receives fund units of a specific unit class. A fund can have different unit classes (or share classes) for different portfolios or for different investment terms of the same portfolio. In such cases, multiple approaches are possible and commonly applied, namely, calculating different NAVs for different unit classes or equalizing the NAV for all unit classes.
Traditionally, investment funds delegate to a fund administrator the central administration of the fund, including the NAV calculation and reporting. Even for a specialized service provider, the NAV calculation and reporting present multiple challenges, among which:
Addressing these challenges is crucial to improving the efficiency, accuracy, and transparency of NAV calculation and reporting in fund management. Emerging technologies like blockchain offer promising solutions to streamline these processes and enhance investor confidence in the integrity of NAV calculations, one such application is FUME.
The core feature of blockchain and distributed ledger technology is the ability to immutably track transactions. This is used to track the ownership of assets on-chain (a.k.a. on the blockchain), starting from crypto assets, to real-world assets, and even complex financial instruments such as alternative investments, investment funds or OTC securities.
In other articles (Tokenized Funds vs. On-chain Fund), we covered the topic of fund tokenization, i.e. bringing the share registrar on-chain, but representing the shares on-chain might not be enough for a fund. Previous sections covered how the NAV calculation has a direct impact on the share registrar, making it essential to integrate it with tokenization.
Bringing the NAV on-chain means writing a smart contract that implements the NAV calculation alongside the tokenization. In doing so, the issuance of shares and the NAV history are precisely calculated and verifiable, leading to multiple benefits:
This model applies to a fund holding any type of asset both on- or off-chain, and requires the fund manager or the central administrator to provide the GAV.
It is worth noticing that further improvement in correctness, transparency and efficiency can be reached when all assets are held on-chain. In such a case, it is also possible to consolidate the GAV from on-chain data, making the process automated and fully verifiable.
The comparison between traditional and on-chain NAV calculations, by adopting Fume outlines a substantial shift towards a more efficient, precise, and transparent model. By harnessing the power of blockchain technology, Fume simplifies traditionally complex processes, offering significant improvements in speed and accuracy.
If you are intrigued by the potential of on-chain fund administration and wish to explore how it can benefit your operations, we invite you to get in touch to learn more. Our team is ready to assist you in setting up your own on-chain fund, guiding you through each step of the process to ensure a seamless and successful transition to the future of finance.
Dive into the future of fund management with Fume. Explore our on-chain administration tool designed to streamline your processes and reduce overhead costs.
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