NAV vs Fair Value: A Total and a Measurement Basis

Fair value and net asset value are not two words for the same thing. Fair value is a basis for measuring one holding, meaning what it would change hands for between willing parties. Net asset value is a total for a whole fund, meaning everything it holds measured on that basis, less what it owes. One is a way of measuring. The other is what the measuring adds up to.

Almost every reader who meets these two words meets them in the same paragraph of the same report, sees a rupee figure attached to each, and reasonably concludes that they are two competing numbers. Neither competes with the other, and the two are not even the same size. The relationship between them is one of construction: fair value is applied to each holding, the results are added together, what the fund owes is subtracted, and the answer is the net asset value. That single sentence is the core of the subject, and everything that follows exists to make the sentence impossible to forget. One of them is an answer and the other is the rule that produced part of the answer, so a reader who has that sentence can never be tricked into asking which of the two figures is the right one.

Are these two words for the same thing?

No, and the fastest way to feel it is to leave finance for a moment and stand in an ordinary household. Suppose a household has a small flat, a scooter, some gold and a fixed deposit, and it still has three years left on a loan against the flat. If somebody asks what the scooter would fetch if it were sold this month, that is a question about one item, and answering it needs a rule: sold to whom, in what condition, in what kind of sale. If somebody instead asks for the net worth of the whole household, the question covers everything at once, and answering it needs every item measured under some rule and then the loan taken off. Nobody in that household would say the scooter's resale figure and the household's net worth are two words for the same thing, and nobody would ask which of the two is the correct number.

A private fund is that household at a larger size and with tighter rules. Fair valueA basis for measuring one holding: what it would change hands for between willing parties, neither under pressure. is the rule the household needed for the scooter, written down and applied consistently. Net asset valueA fund's holdings measured on a stated basis and added together, less what the fund owes, struck at one date. is the household's net worth question, asked of a fund at one named date. The first belongs to a thing. The second belongs to a whole vehicle.

So the two words differ on three axes at once, and it is worth naming all three rather than only the obvious one. One is a method and one is an outcome, so the two differ in kind. One covers a single position and one covers everything, so the two differ in size. And a question aimed at one of them cannot be answered by the other, so the two differ in what they answer. Get any one of the three and the swap stops being possible.

What is a measurement basis, and what does it refuse to say?

A measurement basis is a rule for arriving at a number, agreed before anybody starts arriving at it. Think of two people trying to put a figure on the same second-hand scooter. One of them says it should be what was paid for it four years ago. The other says it should be what a buyer would pay for it this month. Neither is lying and neither is calculating badly. The two are working on two different bases. The number cannot be produced until somebody has said what kind of number it is, so the basis is chosen first.

Cost is a measurement basisThe stated rule under which a number is arrived at, agreed before the number is produced.. Fair value is a different measurement basis. Fair value asks what the thing would change hands for between a willing buyer and a willing seller, neither of them forced, at the date being reported. The basis is nothing more than that: a question with a stated shape, asked of one thing at a time.

Readers overreach on what a basis refuses to give. A basis does not state the answer. A basis states which question the answer is answering. The basis fixes the question and not the inputs, so two careful people applying the same fair value basis to the same unlisted company at the same date can arrive at different numbers. A basis is a rule, not a result, and that is exactly why it cannot be a rival to a total. The inputs a valuer actually uses, and how a carrying value is arrived at from them, are covered separately.

One more thing a basis does not do, and this one matters for the failure later on. Fair value does not promise that anybody has offered that amount, agreed that amount, or paid that amount. Fair value describes a hypothetical transaction between willing parties. On Nilgiri Growth Partners Fund II, invented, at the end of its Year 9 Quarter 2, not one of the five holdings behind the fund's total has been sold to anybody at all.

What is a total, and what is sitting inside it?

A total is an answer, and every honest total carries three things with it: a date, a stated basis, and somebody who struck it. Drop any one of those and the number stops meaning anything. A net asset value is that kind of object. The net asset value is everything the fund holds, each item measured on a stated basis, added together, with what the fund owes taken off, as at one named date.

Here is the fund used throughout. Nilgiri Growth Partners Fund II, invented, is a closed-end growth and buyout fund managed by Nilgiri Alternatives Advisors Private Limited, with Nilgiri Trusteeship Services Private Limited as its trustee and Nilgiri Financial Holdings Private Limited as its sponsor. The fund bought nine companies. Four of those are gone entirely, three sold and one written off in full, and five are still held. Every figure here belongs to the record date at the end of its Year 9 Quarter 2, and the five holdings it still has are carried at Rs 1,08,00,00,000, Rs 21,00,00,000, Rs 39,00,00,000, Rs 81,00,00,000 and Rs 33,00,00,000, and those five numbers add to Rs 2,82,00,00,000.

The whole distinction sits inside that list of five, so the list repays a second look. Each of the five figures is one holding measured on one basis. The sixth figure, Rs 2,82,00,00,000, is not a sixth measurement of anything. Nobody measured it. The sixth figure was arrived at by adding the five and subtracting what the fund owes, and on this fund's own record no liability figure is fixed at that date, so nothing is taken off here. The total is not a bigger version of the basis; it is a different kind of object made out of things the basis produced.

How does one holding's measurement end up inside a fund's total?

By addition, and by nothing more mysterious than that. Each of the five holdings has a carrying valueThe amount a single holding is currently recorded at in the fund's books., the amount that holding is currently recorded at. The five carrying values set in a column, added, and adjusted for anything the fund owes give the struck total. The arithmetic is the easy part. Slow down instead for the change the arithmetic makes to the reader's sense of the number.

Rs 2,82,00,00,000 looks like one solid fact. The figure is five separate estimates of five separate businesses, wearing one label. Holding 4 is Bhavani Speciality Chemicals Private Limited, invented, at Rs 1,08,00,00,000. Holding 6 is Vaigai Edutech Private Limited, invented, at Rs 21,00,00,000 against the Rs 30,00,00,000 the fund paid for it. Holding 7 is Manjira Industrial Services Private Limited, invented, at Rs 39,00,00,000. Holding 8 is Kaveri Renewables Private Limited, invented, at Rs 81,00,00,000. Holding 9 is Indravati Packaging Private Limited, invented, of which 40 per cent was sold in Year 8 Quarter 3 and the remaining 60 per cent is carried at Rs 33,00,00,000. Five different businesses, five different sets of facts, five separate applications of one basis, and one line in a report.

The proportions are worth seeing because they are lopsided in a way the single total hides. Holding 4 is 38.3 per cent of the Rs 2,82,00,00,000 and holding 6 is 7.4 per cent of it. Round all five shares to one decimal and they come to 99.9 rather than 100.0. The shortfall is rounding and nothing else: the unrounded shares add to exactly 100.0, and the honest thing to do is say so rather than nudge one of the printed figures to make the column look tidy.

What happens to the total if the basis changes?

The total moves, and watching it move is the cleanest proof that the two words are not interchangeable. Take the same five holdings of Nilgiri Growth Partners Fund II, invented, on the same date, and add them up twice under two different rules. On a cost basis, meaning what the fund actually paid, the five come to Rs 1,80,00,00,000. The cost total is not guesswork: the fund's nine holdings cost Rs 4,00,00,00,000 in total, and taking out the Rs 45,00,00,000, Rs 35,00,00,000, Rs 70,00,00,000 and Rs 60,00,00,000 of the four positions that are gone, plus the Rs 10,00,00,000 of cost released when 40 per cent of holding 9 was sold, leaves Rs 1,80,00,00,000. On a fair value basis the same five come to Rs 2,82,00,00,000.

Two totals, one set of holdings, one date, and the only thing that changed was the rule. The gap between them is Rs 1,02,00,00,000. The gap settles the idea that net asset value and fair value are competing figures. Change the basis and the net asset value changes with it. Anything contained behaves exactly that way when the container around it is rebuilt. A rival would not behave that way. Neither total is the wrong one either. A cost total answers what was paid. A fair value total answers what the holdings would change hands for. Neither is better than the other.

There is a moment in this fund's own life that makes the point even harder. For its Years 1 to 4 the net asset value of Nilgiri Growth Partners Fund II, invented, equalled the acquisition cost of everything it had bought, to the rupee. The two bases produced identical totals for four straight years. Two numbers being equal did not make the words behind them the same word, and how a fund's value moves across its life is covered separately.

What does each of the two actually answer?

Here is the practical version of the whole distinction, and it is the form worth carrying into a meeting. Before either word is reached for, establish which object the question covers. If the question is about one holding, the object required is that holding's carrying value on a stated basis. If the question is about the whole fund at a date, the object required is the net asset value. The two words are not two answers to one question; they are the answers to two questions of different size.

Fair value answers this: what would this one thing change hands for, between willing parties, at this date, under this rule. Fair value says nothing about how many things there are, nothing about what the vehicle holding them owes, and nothing about anybody's return.

Net asset value answers this: what does this whole vehicle come to at this date, once everything in it has been measured and everything it owes has been taken off. Net asset value says nothing about which holding did what, nothing about which holdings are above or below what was paid for them, and nothing about what any single position would change hands for.

A reader who keeps those two sentences apart cannot be sold a number. A reader who has fused them will nod along to a question that has no answer. The distinction guards against exactly that failure.

Who produces each one, and on what timetable?

Different parties, different objects, different calendars, and this is the most practical way to keep the two words apart. Naming who produced a number already settles which of the two objects it belongs to.

On Nilgiri Growth Partners Fund II, invented, four hands touch this. Palani Valuation Advisors LLP, invented, is the independent valuation agentAn independent party engaged to value the holdings a fund has not sold. and values every unrealised holding once a year, one holding at a time. Nilgiri Alternatives Advisors Private Limited, invented, is the manager and marks the holdings in the quarters between those annual valuations. Kolar Fund Services Private Limited, invented, is the administratorThe party that strikes the fund's net asset value and keeps its books. and strikes the net asset value, the one figure here that is a total. The auditor comes afterwards and reports on the fund's accounts once the period has closed. Three of those four hands produce measurements of single holdings, and exactly one of them produces the total. Each of those roles is covered separately, and what is named here is the hand-off rather than the work.

Because those calendars are not the same, there is a lag between a change in a business and a change in the number reported for it. Two things on this fund's record show it. Holding 3 was carried at 2.00 times its cost at the end of Fund II's Year 7 and was realised at 2.50 times in Year 8 Quarter 1. Holding 6 was carried at cost through Year 5 and was written to 0.70 times at Year 6, with the deterioration visible for three quarters before the markThe act of recording a holding at a value, and the value recorded. moved. How private valuation actually works, and what a lag of that kind costs, are covered separately. Whether the lag makes any mark wrong, or produces a smoother number that somebody benefits from, is a separate question with its own evidence.

How much of this fund's total value is a measurement rather than cash?

The distinction stops being a vocabulary lesson here and starts being worth money. Nilgiri Growth Partners Fund II, invented, has a total value of Rs 7,20,00,00,000 at the end of its Year 9 Quarter 2. The Rs 7,20,00,00,000 has two parts, and the two parts are not the same kind of thing. Rs 4,38,00,00,000 of it is cash that has already gone back to investors in four payments, and cash is not an estimate of anything. Rs 2,82,00,00,000 of it is the five holdings still held, every rupee of which is a measurement.

So 39.2 per cent of the Rs 7,20,00,00,000 of total value this invented fund reports at its record date has never been sold to anybody, and the denominator matters as much as the number. Said against a different denominator it becomes a different figure that is equally true and answers a different question, which is why the denominator is named every single time it appears here. Against the fund's own total value of Rs 7,20,00,00,000, the unsold share is 39.2 per cent.

Both halves of that hold at once. The Rs 2,82,00,00,000 is a properly struck total on a stated basis, produced by the party contracted to strike it, at a named date. And every single input to it is an estimate. Properly struck and entirely estimated are not in conflict, and a reader who thinks they are has fused the total with the basis.

Why do the two words get swapped so often?

Because both are true about the same fund on the same day, and neither sounds wrong in a sentence. The overlap is the honest reason, and saying so plainly beats treating the swap as carelessness. On this fund at this date the sum of the fair values and the struck total happen to be the same number. So if somebody says the fair value of the holdings is Rs 2,82,00,00,000 and somebody else says the net asset value is Rs 2,82,00,00,000, the same figure appears in both sentences and nobody is corrected. The words survive being swapped right up until somebody asks a question, and then the swap costs the answer.

There is a second reason, and it lives in the reports themselves. A report about a fund is full of totals, and totals are what a reader is looking for, so the eye trains itself to treat every rupee figure in the report as a total of something. Fair value is not a total of anything. Fair value is a rule applied many times over, and only its results get added.

What does an analyst do with this in front of a real report?

Three questions, asked of any single rupee figure handed over, and they take about ten seconds each. Somebody analysing a fund for an institution does exactly this with the distinction, and so does somebody sitting on an investor advisory committee before agreeing that a number means what the covering note says it means.

First, which object the figure belongs to: one holding, or the whole vehicle at a date. Second, who produced it and on what timetable. The producer identifies the object. Third, what share of the total has actually been received in cash rather than measured, with the denominator named alongside it. On Nilgiri Growth Partners Fund II, invented, at the end of its Year 9 Quarter 2, that third answer is 39.2 per cent measured against its own Rs 7,20,00,00,000 of total value. None of those three questions requires an opinion about whether any mark is right.

There is a version of this for a household too, and it is the same discipline. A statement that a flat is worth a certain amount is a measurement of one thing under some rule. A statement that a household is worth a certain amount is a total, and the loan against the flat has to be inside it. Which of the two has been handed over is the thing to establish before anything is done with it.