“Opening the Black Box” is our ongoing series on the data treatments, assumptions, and methodologies behind our analyses. In this series, we answer frequently asked questions on how we build, validate, and make decisions about our data.
Thoughts or feedback for us? We welcome it.
In our last post, we looked at how CEM structures asset classes and sub-asset classes so that costs can be compared on common ground. That structure only produces meaningful results if the denominator behind every cost ratio is measured consistently. This post looks at how CEM calculates the fee bases and why the details matter more than they might seem to.
Actual holdings versus economic exposure
CEM asks subscribers to provide actual holdings in the form of net asset values rather than economic exposures. Net asset value (NAV) can be reported either as an average for the reporting period or as a point-in-time figure at period end.
CEM prefers average NAV because the cost basis can change throughout the year due to movements in cash flows. Therefore, costs in basis points are calculated against average holdings, not period-end holdings. Average NAV can be calculated from monthly, quarterly or daily holdings, whichever you track. If you report end-of-period NAVs instead, CEM calculates the average for you using the current and prior periods’ ending figures. So if you only track holdings annually, the average is simply the average of this year’s and last year’s end-of-year holdings.
Getting the NAV for new and terminated mandates right
One of the common questions our team follows up with is ensuring that subscribers are providing appropriate NAV for mandates or programs that are new or terminated partway through the year.
If a mandate or asset class existed for only part of the year, its average NAV should be annualized. For example, say you terminated a mandate in March, with monthly holdings of $200M in January, $250M in February, and $250M in March. The average for the year is $58.3M ($700M divided by 12 months), not $250M for the three months you held the assets. Leaving out the zero months overstates the mandate’s true weight in your average holdings.
Fee basis for private assets
For private assets, CEM also asks subscribers to report the fee basis, i.e., the amount used to calculate fees.
During the commitment period, the fee basis is usually committed capital. Once the commitment period ends, it typically shifts to unreturned invested capital.
Unreturned invested capital can be calculated as:
Contributed capital − Distributed capital + Realized profits
If the fee basis is different than committed capital or unreturned invested capital, we ask for the correct fee basis to be provided.
Notional amounts for derivatives and overlays
For derivatives and overlays, CEM asks for the notional amount, the figure typically used as the basis for computing cash flows in a derivative contract. We ask for gross notional amounts (long plus short), with a small number of exceptions. Duration management programs, for instance, are reported on a net notional basis.
Reporting leverage correctly
If you use explicit leverage at the total fund level, for example, to adjust asset class targets, report your gross leverage as negative cash under the “Cash” asset class. That leverage should also show up in the physical holdings of whichever asset class is levered.
By contrast, implicit leverage used by your managers within an asset class works differently. For implicit leverage, asset class NAVs should be reported net of it.
For example, say you borrow $1 billion from the repo market to commit additional capital to your assets. You would report $1 billion as negative cash and report the NAVs of the levered assets, inclusive of that additional $1 billion. By contrast, if a manager employs implicit leverage within a portfolio company or portfolio property, that is understood to be embedded in the program and does not need to be reported on the survey. We go deeper into how CEM handles leverage in our next blog.
Our committment to you
The trust our subscribers have placed in us over the years, many for close to a decade without interruption, is something we take seriously. This series is one way of honouring that trust. We are not here to simply explain ourselves. We are here to open a dialogue that pushes our work, and the industry, forward.
We look forward to hearing from you. If there is a question you would like us to address, please reach out to us at insights@explorecem.com.
This blog is part of our “Opening the Black Box” series. If you’d like to receive new posts in your inbox, please click here to subscribe.