NAV Errors – That’s Humans For You
If humans are involved in a process, there will be errors. There are often many humans playing their part in the various stages of trade processing, reconciliation, accounting and ultimate production of the net asset valuation, the NAV, of a mutual fund or a hedge fund.
It is the procedures, the people and the control processes in place that can minimise the likelihood of an error arising.
Consequently, if your organisation calculates NAVs, there will be NAV errors. It is the procedures, the people and the control processes in place that can minimise the likelihood of an error arising and, if an error does occur, can maximise the likelihood of the error being identified before it’s too late. In subsequent posts, I’ll be looking at examples of typical causes of NAV errors. For now, let’s consider two things: materiality and impact.
Every fund has a formalised pricing policy that should include the procedure for handling NAV calculation errors. Regulations also play their part. For example, guidelines for determining the materiality of pricing errors could be:
- If a pricing error is less than $0.01 per share, it is immaterial and no corrective action is required.
- If the error equals or exceeds $0.01 per share, then the fund must be compensated for any shortfall in money received from subscriptions or excess money paid out in redemptions.
- If the error exceeds 0.5% of the originally computed NAV, in addition to making the fund whole, individual transactions must be reprocessed. However, if the cash amount of the error for a particular shareholder transaction is less than a de minimus amount (e.g., $10), then that transaction need not be reprocessed.
What is the effect of a material NAV error? Let’s assume the NAV error arose as a result of a fault with the administrator.
Reputational damage. The administrator’s reputation takes a battering in the eyes of the client, the investors and the regulator. In some cases, the general public, and so the broader investment community, might also be made aware of the issue by way of a press release.
Compensation. The administrator might be obliged, or might decide, to compensate the fund for losses incurred as a result of the error.
Time. Depending on the number of NAV calculations affected by the error, there could be a significant amount of work required to recalculate NAVs and revise subscription and redemption amounts and shares in issue.
Morale. Nobody likes messing up. And nobody likes being part of a team that messed up.