Flaws In Net Asset Value Calculations

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Almost all investors pay attention to the record of investment companies. The past record is sometimes called a guide to the future, but this record can be flawed, especially where net asset value is concerned.

This is questionable when stated baldly and without qualification. The record, at least, does show changes in net asset value from one period to another and dividend payments out of investment income and out of capital gains that have been realized. Investment services and commentators have devised methods for comparing the "performance" of investment companies with unmanaged indexes or averages of relevant security prices.

In one important respect, the net asset value as it is invariably stated leaves something to be desired. All the prospectuses, annual reports, and interim reports show the net asset value as of a specific date; in other words, as of Dec. 31 or March 31 of any year. This follows accepted practice in accounting.

This mode of presentation could be improved. It might be desirable for investment companies to publish, along with this information, data on the average net asset value in the aggregate and on a per share basis. The form best serving the purpose would be a 90-day moving average. This proposal may seem theoretical and somewhat radical. Yet, presenting the information in the form of a ninety-day moving average would give the investor a more nearly accurate measure of performance than the present practice. In fact, the present method is in a large degree merely theoretical.

An example will illustrate the defects in the method now used and the advantage of the supplemental information proposed. As of Dec. 31,1959 (or any other year), investment company X had net assets of $10 million, based on closing prices of the securities in its portfolio on that date. The company had outstanding one million shares of capital stock. Therefore, the net asset value per share as of Dec. 31, 1959, was $10 per share. The annual report and prospectus compare this value with that of the previous quarter-year and with earlier periods, but always as of the closing date of the period.

This practice is defective in several respects. First, prices as of one moment in time are fortuitous. Such prices are determined by the conditions of the market on but a single moment of one single day. Changes in prices on any one day may be attributable to factors of a most temporary character: the statement of some political leader, reported changes in credit policy, an oversupply of new security offerings, unexpectedly favorable or unfavorable earnings statements of two or three important corporations, and the like.

Secondly, everyone knows that the net asset value at the close of the market is at best an approximation of the prices, which would be received if immediate liquidation were to take place the following day.

Thirdly, and most significant for the investor's appraisal, it must be realized that the investor uses the net asset value as a measure of what management has done, or what effect the course of the market has had on the value of the company's portfolio. The record as of any one date is not a trustworthy measure.

The best way to avoid falling victim to the appearance of net asset value presentations is by educating yourself on the meaning and calculation behind net asset value.

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