Not too long ago, anyone compiling asset management financial statements had to grab as many Wall Street Journals as they could on January 1 of every year. Why? To grab the “year-end final valuation” of all publicly traded securities from the market close the day before. *A moment of silence to think about that.* I couldn’t imagine being tasked to haul stacks of newspapers around, ultimately having to scour through the infinite pages of tiny script.
To get you up to speed, here’s a quick leveling tutorial. Investments are stratified into 3 levels by liquidity. Level 1 securities are easiest to price and level 3 investments are most difficult to price. From an accounting/valuation perspective, classification is key. We take a conservative approach and don’t want to overestimate the liquidity of every security. Ensuring the true classification of level 1 securities is imperative to preserve conservative pricing techniques.
Asset management valuation employees are quite spoiled now, at least in the context of level 1 (high volume publicly traded securities) and some level 2 investments. The overarching goal is to ensure the internal pricing is consistent with external sources.
With all the current computer APIs (application programming interface) in place, the valuation task is pretty much done for you for majority of securities at most funds. A quick search on the internet for “finance APIs” yields hundreds of APIs full of useful technical details. Many of the financial APIs are free. For example, Yahoo Finance APIs can push dynamic pulls of real-time stock information in seconds. In addition, Bloomberg subscribers can download pre-formatted excel using their API. Simple.
Let’s shift gears to level 2 securities. These securities are not actively traded (have low volume of trading). To identify these securities, the Bloomberg API (and other financial sources) support volume testing. Also, the valuations analyst can immediately classify the level 2 security if it contains certain characteristics (more on that below). If a security has not been traded recently, a valuations analyst can’t rely heavily on the price.
An example of securities that fall into this territory are derivatives. These values can be extrapolated through ordinary calculations with standardized variables, such as underlying interest rates. Again, standard templates and a Bloomberg pull could accomplish this task in seconds. Financial API pull plus a pre-formatted Excel file. Done.
The only exception is level 3 pricing. Due to the fact that level 3 pricing is so subjective, I don’t believe there’s a definitive answer in how to solve pricing through APIs, although I do believe we can automate benchmarking procedures of similar investments.
We’ve come a long way in the valuation world in the past 2 decades, a task that used to take days is now completed in real-time in seconds, changing the valuation game. I’m excited to see what the future holds in this subject area!