Portfolio Valuation – All you need to know
In this article, we will explain the main concepts associated with an investment portfolio and review the most important valuation procedures.
The Global Market Portfolio, encompassing all investable assets, reached an all-time high of USD 175 trillion as of June 2024. The Portfolio Management & Investment Advice industry revenue in the United States has grown at a compound annual growth rate (CAGR) of 6.1% over the past five years, reaching an estimated $543.9 billion in 2024. These figures indicate a growing market for portfolio valuation services, driven by increasing assets under management, the complexity of investment products, and the demand for more frequent and transparent valuations across various asset classes.
As a fundamental element of finance, valuing and managing portfolios is generally regarded as the main pillars of financial planning. Properly valued and managed, especially in the long term, can be a key contributor to overall wealth and financial security. If you’re a business owner, portfolio valuation is essential to determine all your business’s assets, including financial securities and tangible assets like real estate and equipment.
How does portfolio valuation work?
The process of portfolio valuation is carried out by calculating the value of each asset class in the investment portfolio as well as the total portfolio value. The value of each asset is verified by analyzing the total performance, market trends and other factors. In this regard, valuation for financial securities such as stocks and bonds is straightforward, as the price of these assets is fairly available and can be verified easily.
When do you need portfolio valuation?
Effective portfolio valuation is vital for all investors, especially those with a short-term objective. This is because it allows for the proper management of one’s resources, as well as the assessment of the overall returns and risks. The accurate valuation allows you to make better investments, adjust your holdings according to the market conditions and take advantage of the opportunities that arise.
It is also important in terms of accounting, specifically for the reporting of profits and losses, as well as for the preparation of tax returns. As a result, regular portfolio valuation is recommended for all investors, whether they are amateur investors, experienced traders, or professional financial analysts.
Investment portfolio and its valuation
While “portfolio valuation” can refer to any collection of assets, an investment portfolio can be defined as a collection of individual issued securities, such as stocks, bonds and other financial instruments, which are pooled together for the purpose of obtaining a certain level of gains and profits.
The diversity of the potential financial investments takes place because of multiple factors such as the investor’s risk profile, tolerance, current financial situation, future goals, available resources, investing style and timing of the transactions.
All of these elements have a crucial effect on the selection of the considered investments and on the investor’s ability to identify successful and profitable investment opportunities. In general, the more diversified the portfolio is, the more effective it is in minimizing the impact of any single investment’s risk.
What does the portfolio include?
An investment portfolio typically includes many different types of investments such as stocks, bonds, mutual funds, ETFs, commodities, or other financial instruments. Within this group, the selection of securities depends on both the available investment strategies and the intended type of diversification. Here are some of the most common types of investments:
- Bonds – Bonds function as a debt instrument, which means that they represent a loan with an interest rate and duration. Bonds are issued by governments, municipalities and private companies with the purpose of raising money for specific projects. It is relatively straightforward to value bonds because of their common and their liquid nature. In addition to this, bonds have a fairly stable price, which means that their values are not as volatile as the prices of other investments.
- Stocks – Stocks are another type of security that represents ownership in a corporation and comes with possible dividends. Although it is usually riskier than bonds, stocks can generate higher returns. The price of the stock is influenced by the company’s performance, market trends, changes in supply and demand, as well as various other factors. They are the most common type of investment and are used by both individual investors and professionals.
- Alternative investments – Alternative investments refers to investing in any asset class other than stocks, bonds or cash. There are many types of alternative investments, such as hedge funds, private equity, real estate, and commodities. While these instruments may be riskier, however, they provide higher returns and better diversification.
How to build an investment portfolio
In order to properly create an effective investment portfolio, it is necessary to have a comprehensive and accurate knowledge of the market. From asset allocation and asset selection to risk management and reallocation, everything should be thoroughly studied and analyzed. There is no one-size-fits-all approach due to the varying risk profiles, tolerance, financial situation and the different investment objectives of each investor.
The main goal is to carefully process the information regarding the market and its specific changes to minimize losses and maximize returns. Therefore, it is necessary to tailor your portfolio as per your strategies, analysis, goals, knowledge and experience.
Rules and regulations for portfolio valuation
In order to properly value your portfolio, it is important to consider the set of rules and regulations that have been established by financial authorities and regulators. These regulatory requirements help protect investors as well as prevent fraudulent practices in the financial world. Generally Accepted Accounting Principles (GAAP) are the most widely accepted accounting standards which stipulate that GAAP and standards must be strictly followed.
While Securities Exchange Commission (SEC) regulations provide the necessary steps to be followed when valuing security, various acts, including The Private Fund Investment Advisers Registration Act, Dodd-Frank Amendments to Investment Advisers Act, and SEC Enforcement Division’s Asset Management Unit, were passed to regulate the financial industry and protect investors.
Methods to value your portfolio
There are three main valuation methods that can be used to determine the value of your investment portfolio:
Market Approach
This is the most common approach to a portfolio valuation, as it provides an estimate of the value of a security by looking at its market price. Market prices are compared with the ask/bid prices at the time of evaluating the portfolio.
Consider a portfolio that consists of shares from publicly traded technology and consumer goods companies. The market value will be calculated as below:
| Company | Ticker | Shares Held | Market Price per Share ($) | Market Value ($) Shares held X Market price per share |
|---|---|---|---|---|
| Apple Inc. | AAPL | 200 | 150 | 30,000 |
| Microsoft Corp. | MSFT | 100 | 300 | 30,000 |
| Tesla Inc. | TSLA | 50 | 750 | 37,500 |
| Procter & Gamble | PG | 80 | 140 | 11,200 |
| Amazon Inc. | AMZN | 30 | 3,000 | 90,000 |
| Total Portfolio Market Value | $198,700 |
Income Approach
In this approach, the present value of expected future cash flows is calculated by discounting those expected future cash flows at an appropriate rate (discount rate). Typically, asset, debt, or derivative positions will be valued using the income approach.
Consider a portfolio that includes corporate bonds giving the following payout:
- Annual Income: $120,000 (increasing at 3% annually)
- Annual Operating Expenses: $20,000 (increasing at 2% annually)
- Discount Rate (r): 8%
- Time Horizon (n): 5 years
| Year | Projected Income ($) | Projected Operating Expenses ($) | Net Operating Income (NOI) ($) |
|---|---|---|---|
| 1 | 120,000 | 20,000 | 100,000 |
| 2 | 123,600 | 20,400 | 103,200 |
| 3 | 127,308 | 20,808 | 106,500 |
| 4 | 131,127 | 21,224 | 109,903 |
| 5 | 135,061 | 21,648 | 113,413 |
The PV of NOI would be calculated as below:
| Year | Net Operating Income (NOI) ($) | Present Value Factor at 8% (1 / (1 + r)^n) | PV of NOI ($) |
|---|---|---|---|
| 1 | 100,000 | 0.9259 | 92,590 |
| 2 | 103,200 | 0.8573 | 88,473 |
| 3 | 106,500 | 0.7938 | 84,540 |
| 4 | 109,903 | 0.735 | 80,779 |
| 5 | 113,413 | 0.6806 | 77,189 |
| Total PV of NOI (Value of Portfolio) | 423,571 |
Asset Approach
With the asset approach, the value of a fund’s assets, when subtracted from the value of its liabilities, is used as the portfolio value. Basically, the asset approach is used to value assets that have tangible assets such as real estate or equipment.
Consider the below example of a Real Estate company, where the fair market value of assets are determined and the amount of liabilities are deducted as below:
| Asset Type | Description | Market Value ($) |
|---|---|---|
| Commercial Property 1 | Office building in a prime downtown location | 50,000,000 |
| Residential Property 1 | Multi-family apartment complex | 20,000,000 |
| Commercial Property 2 | Industrial warehouse on the city outskirts | 10,000,000 |
| Equipment | Maintenance equipment and company-owned vehicles | 500,000 |
| Cash & Cash Equivalents | Cash in bank accounts | 3,000,000 |
| Accounts Receivable | Outstanding rental income | 700,000 |
| Total Assets | 84,200,000 |
| Liability Type | Description | Value ($) |
|---|---|---|
| Mortgage on Property 1 | Loan (office building) | 25,000,000 |
| Mortgage on Property 2 | Loan (apartment complex) | 12,000,000 |
| Accounts Payable | Outstanding payments (contractors/vendors) | 300,000 |
| Accrued Expenses | Employee salaries, and property taxes | 1,200,000 |
| Total Liabilities | 38,500,000 |
Company’s Portfolio Valuation (Net Asset Value) = Total Assets – Total Liabilities
= 84,200,000 – 38,500,000 = 45,700,000
How do DLOC and DLOM work in portfolio valuation?
Discount for Lack of Control (DLOC) and Discount for Lack of Marketability (DLOM) are two valuation methods that can be used to value an investment portfolio. In DLOC, investors in capital markets generally pay a premium for control rights and thereby demand discounts for lack of control.
On the other hand, in DLOM, the minority interests in private companies are often difficult to sell, whereas the interest in a closely held business is worthless. Therefore, this method requires a discount for lack of marketability.
Why choose Eqvista for your portfolio valuation?
In conclusion, portfolio valuation is a crucial procedure that must be followed by investors in order to make well-informed investment decisions and reduce risk. Effective portfolio valuation also helps prepare accurate financial statements and improves overall transparency.
Eqvista’s valuation services aim to simplify the complex task of valuing diverse portfolios while ensuring both accuracy and compliance with financial regulations. Depending on their needs, you can opt for annual, quarterly, or monthly valuation reports. This flexibility allows for active portfolio management and timely financial reporting. Contact us to know more about Eqvista’s specialized valuation services.
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