NAV for funds with public & private

Ah, you're diving into the nuanced world of fund accounting and performance measurement, a topic that's as intriguing as it is complex. Let's break it down based on the most helpful WSO content and what we know about hedge funds (HFs) and private equity (PE) funds.

Hedge funds and private equity funds approach the valuation of their holdings differently, primarily due to the nature of their investments and the structure of their returns. Hedge funds, which may invest in both public and private assets, typically mark their portfolios to market, meaning they adjust the value of their holdings to reflect current market prices. This is straightforward for public securities with readily available market prices but gets trickier with private holdings.

For private assets, hedge funds might adopt a valuation approach similar to PE, marking these assets to "fair value" based on internal models, recent transactions, or third-party valuations. This process is subject to rigorous scrutiny and must adhere to the fund's valuation policy as well as industry standards, such as those outlined by the Financial Accounting Standards Board (FASB) in the U.S.

Regarding performance fees and the treatment of unrealized gains, hedge funds typically calculate their fees based on both realized and unrealized gains, thus affecting the fund's Net Asset Value (NAV). This means that increases in the value of both public and private holdings can contribute to the NAV and, by extension, the performance fees earned by the managers.

Private equity funds, on the other hand, usually earn their performance fees (carried interest) based on actual cash distributions to investors, which occur upon the realization of investments through exits. This model aligns the interests of PE managers with the long-term performance of the assets.

For a fund that holds both public and private investments, the treatment of private assets for performance fee calculation could indeed follow a hybrid approach. They might mark these assets to fair value, similar to PE practices, and include some form of clawback or high-water mark provision to ensure that performance fees are ultimately aligned with realized gains. This means if the asset is later sold for less than its previously marked value, adjustments to fees may be required to reflect the actual performance.

However, the specific approach would depend on the fund's structure, its valuation policies, and the agreements with its investors. Some funds might choose to hold private assets at cost until a liquidity event, relying on distributions or earnings from these investments to contribute to the fund's performance in a more conservative manner.

In summary, for a fund investing in both public and private holdings, the valuation and performance fee calculation can be complex and would likely incorporate elements of both HF and PE practices, tailored to the specific strategy and investor agreements of the fund.

Sources: Secondary PE Modeling, Hedge funds vs. Mutual funds, Request: Day in the life of Mutual Funds Administrator, Hedge funds vs. Mutual funds, LPs/Investor Return Structure