Fair value measurement of private placements: A challenge for pension plans
Private placements are traded over-the-counter through private offerings. Most investments in these types of vehicles are carried out through private equity funds or funds of funds. Funds hold capital stock of various, usually private, companies or fund units. Private placements are illiquid and have a limited time horizon (i.e. 7 to 10 years), which is determined when the fund is created.
Fair value measurement: A complex process
Measuring the fair value of an asset involves estimating the price that would be received if the asset were sold in an orderly transaction. Because private placements are illiquid and there is little market data about them, there are few comparable transactions available on which measurement can be based.
Private funds value their positions through different methodologies which are generally based on valuation methods and techniques, such as discounted cash flows and earnings multiples. Investors measure their investments in these funds by using the net asset value (NAV) provided by fund promoters. Private placements are categorized within Level 3 of the fair value hierarchy under IFRS 13 and the Appendix to Section 4600.
Audited financial statements showing fund investments at fair value are sometimes available several months after the financial statement reporting date of institutional investors, including pension plans.
Financial statement preparers determine the fair value of their investment in a fund using the net asset value (NAV) per unit based on the most recent financial statements provided by the fund promoter. This value is adjusted for acquisitions and disposals of fund units made between the date of the fund’s financial statements and the investors’ financial statement reporting date.
The value of these funds in the year-end financial statements of pension plans is often based on unaudited three-month-old information. Fair value differentials can be even more significant since some funds do not remeasure their assets quarterly. In addition, there is little information about the assumptions used to determine the fair value of these funds and the risks of using reasonable assumptions.
For most pension plans, private placements represent a small portion of assets invested compared to traditional investments. The fair value differentials mentioned above are often immaterial to financial statements of institutional investors. However, given the growing importance of private placements, efforts will have to be made to ensure these differentials remain immaterial.
Otherwise, a method of obtaining evidence must be found to properly measure the fair value of private placements, assess its reasonableness and disclose the risks involved.
The Order’s Working group on pension plans