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8 Placing a value on a portfolio of investments The approaches that we have covered so far in this chapter to value individual investments can also be used to value a portfolio of investments. The straightforward way of valuing a portfolio of investments is to sum the market values of the individual holdings, or if there is no active market, a proxy market value. In the past other methods have been used that generate a method of asset valuation from the features of the liabilities. In particular discounted cashflow techniques were used historically, with both the asset proceeds and liability outgo discounted at the same rate and consistent assumptions used for the valuation. However, most of these methods are becoming less common in practice. Instead, effort is spent in determining methods and bases for the valuation of liabilities that are consistent with a market value of assets. Some of the other methods of asset valuation that are still in use are mentioned below. 8.1 Purpose of the valuation The method and basis for any actuarial valuation will depend on the purpose of the valuation and the type of liability. Valuations for regulatory purposes For certain supervisory valuations the actuarial method and basis will be set out in regulations. In other cases there is less prescription. Discontinuance valuation Sometimes funds are valued assuming an immediate windup. In this case assets need to be valued at their immediate realisable value. Usually this means looking at the realisable market value ie the bid value and comparing this with the liabilities on a discontinuance basis eg a pension fund buying insurance contracts to provide pension benefits. Approaches such as smoothed market value and discounted cashflow are unlikely to be appropriate. Ongoing valuation If the liabilities are being valued on the assumption that the fund is ongoing then the assets should be valued on the assumption that the investments are managed on an ongoing basis too. If the liabilities are considered as a stream of future cash outflows, the discounted cashflow approach to valuing assets may be more appropriate than, say, a market value approach. Alternatively, a market value of assets may be appropriate if associated with a valuation of the liabilities performed at market rates of interest. 8.2 The need for consistency when valuing assets and liabilities It is important that the valuation of assets and liabilities are consistent. To achieve consistency this means that if assets are valued at market value then liabilities should be valued at appropriate marketbased discount rates. It may be difficult to determine an appropriate marketrelated discount rate. Alternatively, both assets and liabilities could be valued using the same interest rate, which would normally represent the longterm expected return on the assets held to back the liabilities. Question Outline the main advantages and disadvantages of valuing both assets and liabilities using an interest rate representing the longterm expected return on the assets. Solution Advantage The interest rate used for discounting will be stable, so yielding stable valuation results. Advantage Easier to ensure that the discount rates used to value assets and liabilities are consistent. Advantage Removes the difficulties involved with determining suitable marketbased discount rates. Disadvantage The discount rate used is entirely subjective. Disadvantage A single discount rate is unrealistic, as investment returns will vary over time. Disadvantage It may be difficult to explain or justify to other parties, eg trustees or directors. End of question Alternative approaches include to use a single marketrelated interest rate to discount all future liabilities, reflecting the average rate of expected return expected across the entire asset portfolio of the fund, to use different assets to match different types of liability by nature, term etc and then discount each liability type by the average rate of expected return on the matching assets. Any market value implies an expected rate of return linked to the risk of the asset. Therefore, it can be argued that the use of a single discount rate to value all assets and liabilities is inappropriate and different discount rates should be used depending on the risks within the assets and liabilities to be valued and possibly other factors such as marketability and term. So consistency does not necessarily mean that all assets and all liabilities must be valued using exactly the same interest rates for discounting. The issues around valuing liabilities are explored further in a later chapter on the Valuation of liabilities.