On the surface, a hedge fund appears quite similar to a mutual fund. Both organizations pool money from investors and use that money to generate the highest possible return on stocks, bonds, commodities, currencies and other investment vehicles. Hedge funds and mutual funds earn money from management fees they charge. Their managers, in turn, are responsible for choosing investments and keeping shareholders up to date on fund performance – a task that begins with a calculation of the all-important net asset value, or NAV.
Attempt to access the fund's current portfolio, which lists all securities held by the fund as well as the number of shares or contracts of each. The portfolio may include stocks, bonds, options, currency positions, futures contracts and derivatives. The fund should make this roster available on an ongoing basis to all investors; some hedge funds will not release the information to the general public, however, and as these funds do not submit to Securities and Exchange Commission (SEC) regulation, there is little an outsider can do to force disclosure.
Calculate the aggregate value of the securities and/or contracts by applying the most reliable and current information on their worth. Many hedge funds hold illiquid securities, which unlike stocks and bonds, do not have a widely published daily opening and closing price. For these securities, you may need to obtain price quotes from brokers or counter-parties.
Subtract the liabilities from the aggregate asset value. Liabilities may include interest and principal payments on loans, pending fees to management, dividends declared but not yet paid to investors, and accounts payable for securities transactions.
Calculate net asset value by adding the current value of all investments, subtracting liabilities, and dividing the result by the number of shares outstanding. A fund with investments worth $10 million and liabilities of $1 million, and which has issued 1 million shares would, therefore, have a net asset value of $9 per share.
For potential investors, hedge funds demand very thorough due diligence, especially with regard to the calculation of NAV. Hedge fund managers must explain the process for calculating the value of their investments and make this valuation as transparent as possible. They should apply the same pricing methods to all similar securities, and rely consistently on the same source for prices, whether this source is a broker, a market maker, or a public exchange.
An independent calculation of NAV is important to a properly managed hedge fund. This means allowing third-party administrators to oversee the pricing process to make sure it is accurate and fair. Managers who have a financial interest in the fund’s performance should not be the ones pricing the fund’s investments or calculating the NAV.
Fees charged to investors are calculated on the NAV return "gross of fees," meaning the fund first calculates total return, then charges fees on the gain.
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