Investment Company Notebook

Practical insight and analysis on the accounting, audit and tax issues impacting investment companies.

Valuing Private Investments in Mutual Funds and Interval Funds

Many advisers of registered products, including mutual funds and closed-end interval funds, invest in private alternative investments as part of their portfolio strategy. And generally, they are permitted by the Investment Advisers Act of 1940 to do so. While mutual funds are restricted to investing up to 15% of net assets in illiquid securities, there are no such restrictions for interval funds.

In either case, these funds are computing a daily net asset value defined by Rule 2a-4 of the 1940 Act that contemplates in part the following:   

 “Portfolio securities with respect to which market quotations are readily available shall be valued at current market value, and other securities and assets shall be valued at fair value as determined in good faith by the board of directors of the registered company.”


ICYMI Morgan Lewis


As one can imagine, valuing illiquid assets on a daily basis can present unique issues that must be seriously considered prior to the initial investment and as part of an investment adviser’s initial due diligence of the investment – not after the fact. Whether this is an investment adviser’s first foray into managing a registered investment company or just a one-off alternative investment, an adviser should appreciate the consequences of a daily traded fund investing in private investments.  After all, the adviser is ultimately responsible for the management of the fund and its investments in the eyes of the Securities and Exchange Commission, of course with the oversight of the fund’s Board of Directors/Trustees.

Below are some considerations relative to valuing private investments. We’ve broken the considerations into two general categories: 1) Topic 946 Investments and 2) Other Fair Valued Investments:

Topic 946 (Net Asset Value) Investments: A net asset value is computed periodically and provided to the adviser who can place reliance on this value subject to certain conditions

How often are NAVs computed? How will daily prices be computed intra-period by management? Consider testing to evaluate the strength of the intra-period pricing by management.

If a given investment is providing NAVs monthly, the adviser should consider how the fund is going to translate that into a daily price. Many advisers use the latest NAV and then adjust for a relative index which has proven to correlate to the NAV received the following month. Correlation testing shows a track record of the adviser attempting to use the best estimate of value intra-period and helps to improve the daily estimation process over time.

Is the NAV being computed by an administrator or in-house? Is a Service Organization Control Report (SOC) available for the administrator?

Consideration of the controls at the underlying investment’s administrator and their effectiveness provides comfort that the NAVs the adviser is receiving represent fair values.

Is the underlying investment being audited? Is that auditor reputable?

A clean audit report from a reputable auditor also provides comfort that the NAVs being computed for a given investment are accurate at the audit date. The adviser may conclude that similar procedures and controls are in effect when subsequent periodic NAVs are computed. The notes to the financial statements usually indicate whether the underlying investment is computing its value consistent with Topic 946.

Are there controls relating to pricing at the adviser?


While the adviser for mutual funds and interval funds is usually relying on third parties to perform certain functions relating to valuation, the adviser is ultimately responsible and should therefore have controls in place to give comfort with the fact that the third party service providers are performing their duties appropriately.

For example, the adviser should be monitoring the valuation of investments making use of net asset values by receiving net asset values independently from the underlying investment for comparison to what the fund is reporting.

Other Fair Valued Investments: These are investments that are being fair valued using a variety of methodologies, as there is a lack of observable inputs (market and/or broker prices).

Is management of the underlying investment able to provide a periodic valuation of the investment? If so, how often and what insight are they willing/able to provide relative to the methodology? How will the investment be valued by the fund between valuations provided by management of the underlying investment?

Very few private investments are going to provide frequent valuation updates. If a fund does invest in a private offering that will provide a periodic valuation, it is still the adviser’s responsibility to understand the methodology and the reasonableness of it. From there, the adviser is responsible for determining a reasonable method to valuing these investments on a daily basis.

If management of the underlying investment is not able to provide periodic valuations, then consider how the fund will value the underlying investment. Consider the use of an independent valuation expert, even if just for a periodic evaluation used to test assumptions, reconsider the methodology and how it is tracking.

In all likelihood, the adviser will be responsible for either determining a methodology to fair value the investments daily or hiring a valuation expert. Recognizing there are costs relating to the use of a valuation expert, there are also benefits, including the insight an independent expert might provide and testing that can be performed to provide further comfort that the valuation process is reasonable. In addition, auditors are also able to make use of independent valuation experts for their purposes if the values are obtained for reporting period-ends.

Look-Back Testing

This can be difficult to apply, as there might not be much in the way of redemptions of a given investment. To the extent that there are, comparing the value the fund is using daily to the value the fund is able to redeem for often provides excellent evidence for the valuation process being used.

Is the underlying investment being audited? Is that auditor reputable? Consideration of whether the audited financials have a significant impact on the value of the underlying company and your investment.

Before investing, consider whether or not the underlying investment is being audited by a reputable firm. The very fact that a company is not having an annual financial statement audit performed might be cause for concern. There might be also be very good reasons they do not engage an auditor. Having an audit report is certainly a useful piece of evidence when performing due diligence and in considering the valuation of a given investment.

Are there controls relating to pricing at the adviser?

As noted above, the adviser is ultimately responsible for the valuation of the investments held in the fund and should therefore have controls in place to give comfort with the values that are being used and inputs being used to compute values whether they are observable or unobservable. Documentation of monitoring and testing of values are often very useful for discussion with regulators and auditors.


The fact that these registered funds trade daily (only subscriptions in the case of the interval fund) suggests that the net asset values being used by the funds need to be as accurate as possible on a daily basis, which necessitates good underlying estimates of the valuation of investments held each day. The adviser’s part in this valuation process is essential and bridges the concept of including illiquid investments within a daily traded product. In this light, investors depend on advisers to take the investment in alternative investments and the valuation of such seriously by performing appropriate due diligence, adequate monitoring and detailed testing during the holding period, and ultimately reporting to the Board of Directors/Trustees for the protection of the investing public.