NAV, and the independent valuation that anchors it

Graduate · enrolled learners

This lesson opens with Weavering Capital, 2009.

What happened

Weavering Capital ran a hedge fund that reported steady, positive returns and a healthy net asset value, the NAV that told investors what the fund was worth. The returns were manufactured. The fund's assets consisted largely of interest-rate swaps, and those swaps were transacted not at arm's length with an independent counterparty but with a related company controlled by the same manager, so the fund's main asset was effectively a promise from an entity the manager controlled. By setting the terms of those swaps, the manager could make the fund's NAV whatever he wanted, and he made it show consistent gains. The valuation was self-referential: the fund was worth what it claimed because it valued its own related-party swaps at the claimed amount, with no independent valuation forcing the number to reality. When redemptions came in 2009 and the fund could not pay, the swaps were revealed as near-worthless, the NAV collapsed by on the order of 600 million dollars, and the manager was later convicted of fraud. The NAV had been a number the manager set by valuing his own promises to himself.

The decision point

A fund's net asset value is the value of its assets, and it is only as real as the valuation of those assets is independent and arm's-length. When a fund's assets are valued using inputs the manager controls, related-party transactions, self-referential marks, prices the manager sets, the NAV stops measuring the assets and starts measuring the manager's chosen number, and it can show anything. Weavering is the case: the fund's main assets were swaps with a related party the manager controlled, so he could set the NAV at will, and it showed steady gains until it collapsed by hundreds of millions. This is why an independent valuation, and an independent administrator to strike the NAV from it, is the anchor that makes a NAV mean anything: it forces the number to come from arm's-length values rather than the manager's own inputs. For a tokenized fund or asset, the NAV that holders trust is subject to exactly this failure, because a tokenized structure can encode a NAV that is computed from the sponsor's own marks or related-party inputs and looks precise and automated while being circular. So the decision when structuring or holding a tokenized fund is to require that its NAV be struck by an independent administrator from genuinely independent, arm's-length valuations, because a NAV built on inputs the manager controls is not a valuation at all, it is a number the manager set, as Weavering's was.

Recorded loss

$630,000,000

Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.

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