Nav Of The Hedge Funds

Real-Time NAV: A paradigm shift for Hedge Fund Industry BALA NAGENDRA BETHA Satyam Computer Services Limited TSR Towers, Rajbhavan Road, Somajiguda, Hyderabad – 500 082 INDIA [email protected] http://www.satyam.com Abstract: - Real-Time NAV improves transparency in Hedge Fund industry taking

investor satisfaction to a different level altogether. With a gamut of related real-time functionalities like Equalization, Partnership Allocation and Portfolio Management, the Hedge Fund Industry could benefit from a real-time environment. Elimination of lock-ins is another added feature. Keywords- Mutual Funds, Hedge Funds, Fund of Hedge Funds, Net Asset Value, Equalization, Redemption, Partnership Allocation, Portfolio Management, Quantitative Finance

1 Introduction Hedge Funds have huge assets under administration (AUA), to the tune of billions of dollars. Often Hedge Funds are monitored by their Net Asset Values (NAV). NAV is calculated on a daily, weekly or monthly frequency. Investments in Hedge Funds are considered long term and returns slow. [8] Hedge Funds have varying degree of automations from excel sheets to highly sophisticated web-enabled internet applications. The purpose of this paper is to highlight the need for real-time NAV calculation and how it is going to benefit the industry.

2 Definition of NAV A formal definition of NAV will follow shortly but first we understand the difference between Funds and Stocks.

2.1 Differences between Stocks and Funds Stocks are tradable in the market. Prices of stocks are deterministic, by the market. While, fund is a collection of such stocks and its price is determined by the price of underlying stocks. Hence, NAV is

important to a fund or fund of funds such as Fund of Hedge Funds. As the level of abstraction grows, tools like NAV become more important to assess its performance. Definition of NAV: The market value of a fund's total assets, minus liabilities, divided by the number of shares outstanding. [1] It is a fairly simplistic definition, assets minus liabilities by shares. But the actual process of calculating NAV involves lot more complication and delays are induced by sequence of events.

2.2 Importance Investors

of

NAV

to

The primary responsibilities investors assign to Hedge Fund Administrators are: a. Fund Accounting b. NAV Calculations c. Fund Transfers and d. Risk Analysis and Investor Relations. [2] As one can see, NAV calculation is the second most important responsibility of a Fund Administrator. At the same time we have seen Fund Administrators being praised by investors for the timeliness and accuracy of their NAV calculations. Accuracy of NAV is of importance to

investor confidence Administrator. [5], [6], [7]

2.3

in

Fund

Hurdles are set using NAV

One of the primary uses of NAV is setting hurdles for a Hedge Fund. Based on, whether hurdle is achieved or not, investors pay incentive fee to the Hedge Fund Administrator.

3 3.1

Real-Time NAV Need for Real-Time NAV

Calculation of NAV involves a complex formula and induced delays. But with automation, it could be simplified. Most of the funds calculate NAV on a daily, monthly frequency. If the technology for calculating NAV at real-time basis is available, it will certainly boost fund performance and investor confidence.

3.3 Real-Time NAV: Over-kill or paradigm shift In the past, real-time applications have revolutionized the market. Questions linger whether it is an overkill to calculate the NAV for each transaction while most of the finds calculate NAV at monthly, daily intervals. However, speedier availability of information is never a curse for Fund Administrator or Investor. Online information providers of stock markets, now think on how to eliminate network latency from its applications to synchronize itself with market absolutely.

3.2 Process for Real-Time NAV calculation NAV works by abstracting stock prices into portfolio NAV. Portfolio NAV is abstracted into Hedge Fund NAV.

And in case of Fund of Hedge Funds, there is one more level of abstraction.

We know that a paradigm shift is required to bring this approach into service. Next generation of Hedge Funds will treat information in real-time basis and allow greater freedom to get in and out of Hedge Fund to investors in a volatile market conditions. The way hedge funds are working today:

Real-time NAV will bring browser-based information boom into Hedge Fund Administration. The same technology could be applied for other difficult areas like Equalization, Partnership Allocation and convert the Hedge Fund Administration into a real-time application. [3], [4]

Bridge is a self contained program with limited access to database. In our case the Real-Time Data Converter is a Bridge. It converts the data-feeds coming from Investment Managers with zero-latency. Converted data from Bridge becomes input to Real-Time NAV Calculator. Calculator Black-box, formula of NAV is a black-box from system perspective as different dealers use different formula. The black-box will take inputs and throw outputs. In-between, the formula will be driven by the users. [9]

4 4.1

3.4

Events, Delays and Routers

Benefits Lock-ins are optional

Hedge Funds lock investors for at least a month before redemption. This compromises investor’s interests. Operational bottlenecks like availability of funds for paying redeeming investors etc. could be important but technology is available to bring zero lock-in periods for investors into force.

The approach is technology-agnostic. Any real-time application will have Events and Events have delays.

4.2 Double taxation: A Double edged sword?

Events are like arrival of data, manual corrections to data etc. For every event there is an associated Event Handler which processes the payload assigned to the event. Events cannot fire in recursively whether in long loops or short loops.

Another major pain area for Hedge Fund Administrator is Taxation. Generally, investors come with cross-border and across countries investments. To avoid double taxation and benefit investor with tax savings is the prime objective. A sound database of international double taxation treaties helps in knowing the tax liabilities. [4]

Delays in the process are injected due to manual processes. A delay is something like a manual adjustment entry, open or closing of a period etc.

5 Conclusions The primordial question is why only the fittest survive. Hedge Funds are known for slower returns and long-term investments, which could damage its image. That could be changed to real-time information environment. More investors will move towards Funds with greater agility of investment, transparency and information richness. References: [1] www.amex.com [2] www.institutionalinvestor.com [3] The Capital Guide to Hedge Funds 2003 – ISI Publications [4] http://en.wikipedia.org/wiki/Hedg e_fund [5] www.hedgeweek.com [6] www.bloomberg.com [7] www.standardandpoors.com [8] “Servicing an asset class that’s here to stay” interview with William Keunen, European Fund Strategy, June 2004 [9] NAV/Fair Value Practices Survey Overview, Capital Market Risk Advisors (CMRA), USA Bala Nagendra Betha, PMP is a Hedge Fund Data Modeling Specialist. He works in Technology Architecture Group (TAG) of Satyam Computer Services Limited, India. He has over 20 years of experience in software industry and his area of interest is Relational Database Management System (RDBMS).