Unfair Value
If you’re in the business of investing, your product is returns, which is to say that if you’re in the business of investing, returns are what your customer expects. But unlike other products, to the chagrin of customers and proprietors alike in this space, returns can’t be manufactured at scale on an assembly line according to a production schedule. In fact, by trying to manufacture returns, investors often do worse (and/or commit fraud).
Yet if you don’t have a product that you can reliably manufacture at scale and on schedule, you arguably don’t have a business. And since I’m in the business of investing, I was some combination of outraged, amused, impressed, bewildered, skeptical, and cynical when I read about Hamilton Lane, a fund that reported that on one investment of pretty good size they made 39% in a day. And further that they had done stuff like that before.
The trick is that Hamilton Lane went into the secondary market for illiquid private investments and bought something for a price no one else would pay. Then they marked the value of that investment on their own balance sheet not at what they paid (or cost, as the nerds would say), but at a higher “fair value” (which is even nerdier) with “fair value” being what other people who owned shares in that investment thought it was worth.
Of course, people who own things have every interest in portraying them as worth more. An opposing force is that buyers have an interest in acquiring those things at a price that is less. What’s the truth? Who knows?
Because arguably Hamilton Lane shouldn’t have marked the investment at the value others were carrying it at, but rather that the others all should have marked their investments to the value that Hamilton Lane had just paid.
But Hamilton Lane isn’t the only one in this industry massaging returns by citing fair value. To wit, mammoth financial firm Blackstone’s $59B real estate trust is kicking ass only if you are willing to give it credit for the “appraised values” of its investments. What are appraised values? They’re numbers in spreadsheets, not numbers being offered by buyers.
Is this a problem? I think yes and no.
Returns are what you put in your pocket (hello, beer money!), but an important qualifier is that what you put in your pocket depends on when you decide to pocket it and why. In other words, if you buy or sell something, you may transact at fair value, but more likely you’re not. Because the reason you’re transacting is because the price is a lot more or a lot less. In Hamilton Lane’s case, for example, they may have gotten a great deal (unfair value?) because the seller was distressed and they were the only ones who could wire it money that day and so maybe they were right to then mark it up?
This is why this stuff is confusing.
A better way to think about it is that there are two types of value: Spreadsheet Value, which is an academic estimate, and Real World Value, which is what a willing buyer would give you in cash today. And both numbers are worth acknowledging and knowing because rarely are they the same.
As for which one is “fair,” that depends. And that’s why returns are so hard to manufacture (absent, of course, fraud).
-Tim
