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Fair value measurement of private placements: A challenge for pension plans

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Updated : December 18, 2018

In an economic environment of low interest rates and volatile returns, pension plan managers are looking to diversify their portfolios while earning higher returns. To this end, a new investment category has recently been added to traditional equity and fixed-income investment portfolios: private placements.

In an economic environment of low interest rates and volatile returns, pension plan managers are looking to diversPrivate 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.ify their portfolios while earning higher returns. To this end, a new investment category has recently been added to traditional equity and fixed-income investment portfolios: private placements. 

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. When the values assigned to these investments are based on unobservable inputs, they 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. The quarterly statements provided by managers can be difficult to reconcile with the audited financial statements at year-end due to changes in the recognition of income and expenses during the year which are not necessarily communicated to investors. The figures in the financial statements should be the same as the values of the investor’s custodian and the plan manager.

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.

Consequently, financial statement preparers should carry out a retrospective comparison of the unaudited value in the financial statements at the NAV based on the funds’ audited financial statements, once available, to ensure that the process used to determine the value for financial statement reporting purposes is appropriate.

Conclusion

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 in the 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 Sector-specific working group on pension plans

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