# Fund Valuation: NAV, Dealing Prices and Liquidity

> How fund NAV is produced, who answers when it is wrong, and why value is not cash: fair-value hierarchy, AIFMD and SEC Rule 2a-5, dealing cut-offs, NAV-error thresholds, gates and side pockets.

Canonical: https://wiki.private.law/en/fund-valuation-nav
Topics: structures
Jurisdictions: global
Semantic tags: fund-vehicle

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## Why NAV is a produced number, not an observed one

> 💡 Net asset value is the output of a valuation process someone controls — not a market price. Whether you can actually exit at it depends on three separate things: what the fund documents promise, what the manager decides on the day, and what the regulator permits or forces. For most private funds at least one of the three says no.

Net asset value (**NAV**) is the value of a fund's assets minus its liabilities, divided into units or shares. Everything in fund economics hangs off this number: the price at which investors enter and leave an open-ended fund, the management fee base, performance fees and hurdles, the borrowing base of a [NAV facility](https://wiki.private.law/en/fund-finance), and the reference point against which a [secondary buyer](https://wiki.private.law/en/fund-secondaries) quotes a discount. Yet NAV is not observed anywhere. It is produced — by applying a valuation policy to a portfolio, some of which trades daily on an exchange and some of which has not traded since the fund bought it.

The legal right NAV creates is narrower than most investors assume. In an open-ended fund, the constitutional documents typically oblige the fund to redeem at a dealing price derived from NAV — subject to gates, suspension powers, fees and notice periods written into the same documents. In a closed-ended fund there is no redemption right at all: NAV is a reporting and fee-calculation number, and the only ways out are distributions in the [waterfall](https://wiki.private.law/en/private-funds-structure-documents) or a secondary sale at whatever price a buyer will pay. "Redemption at NAV" is therefore never a universal promise; it is a contractual mechanism with contractual exceptions, operated by a manager with discretion, inside a regulatory boundary.

One example shows the whole machine. An open-ended credit fund holds mostly liquid bonds plus one private loan carried at cost. The borrower deteriorates; no market price exists to force a write-down. Until the manager's valuation process recognises the loss, the fund's NAV is overstated — and every investor who redeems in that window is paid more than their share is worth, out of assets that belong to those who stay. When the loss is finally recognised, it lands entirely on the remaining investors. Nothing in this sequence requires bad faith: it is the mechanical consequence of a stale input meeting an open door.

Three features of the system drive everything below. First, valuation quality is asset-dependent: a listed equity needs no judgment, a Level 3 private position is nothing but judgment, and the same fund usually holds both. Second, the parties who produce NAV — manager, administrator, external valuer — have different incentives and different legal duties, and the conflicts are structural, not incidental. Third, NAV and liquidity are independent variables: a fund can be correctly valued and still unable to pay redemptions, because NAV measures value, not cash. A fund holding a fairly valued office building has NAV; it does not have money.

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## Valuation basis: observable prices and model inputs

Fund valuation borrows its conceptual frame from fair value accounting. IFRS 13 defines fair value as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date, and sorts inputs into a three-level hierarchy: **Level 1** — unadjusted quoted prices in active markets for identical assets; **Level 2** — other observable inputs, such as quotes for similar instruments or rate curves; **Level 3** — unobservable inputs supplied by the valuer's own assumptions. US GAAP (ASC 820) uses the same architecture. The hierarchy is not decoration: the standard requires observable inputs to be maximised, and the further down the hierarchy a position sits, the more its reported value is a claim by the manager rather than a fact about the market.

Private equity, venture, private credit and real assets live almost entirely at Level 3. Industry practice there is codified in the IPEV Valuation Guidelines (current edition published 11 December 2025) — recommendations endorsed by industry associations, not law. The techniques are familiar: earnings multiples calibrated to comparable companies, discounted cash flow, and the price of a recent financing round — which, importantly, is a data point to be calibrated against, not a value to be carried indefinitely.

That last point names the central defect of Level 3 portfolios: **stale pricing**. A valuation done at entry, or at the last funding round, stays on the books until something forces an update. The EU regime addresses this directly: for open-ended AIFs, financial instruments must be revalued every time NAV is calculated, while other assets must be revalued at least annually *and whenever there is evidence that the last determined value is no longer fair or proper* (Commission Delegated Regulation (EU) 231/2013, Article 74). The same regulation requires valuation procedures to include testing for stale prices and implied parameters (Article 71(3)(g)). The rule exists precisely because the default behaviour of an unforced valuation is to stand still while the world moves.

> ⚠️ A NAV computed from stale Level 3 marks is not conservative — it is directional. In a falling market it overstates value, which systematically favours whoever exits first and penalises whoever stays. Valuation lag is not a technicality; it is a wealth-transfer mechanism.

### What NAV is not

Five numbers in a fund's paperwork sit next to NAV or borrow its name, and confusing them is the commonest reading error in a fund report.

| **Number** | **What it actually is** | **Why it is not the NAV** |
| --- | --- | --- |
| Dealing price | the price at which a subscription or redemption is executed | NAV adjusted by swing pricing, dual pricing, an anti-dilution levy or a redemption fee — deliberately, so that transaction costs follow the transactor |
| Market price of a listed fund | what a share in a listed closed-ended vehicle trades at on an exchange | set by supply and demand for the shares, not by the portfolio; it stands at a discount or premium to NAV, and nothing obliges the fund to close the gap |
| Secondary transfer price | what a buyer pays for a fund interest today | prices immediate liquidity, the unfunded commitment assumed, and the buyer's own view of the marks |
| Borrowing base of a NAV facility | the lender's contractual measure of collateral value | defined by the credit agreement — eligibility criteria, concentration caps, advance rates — not by the published NAV |
| Net assets in the audited accounts | the year-end figure signed off under the accounting framework | struck once, on one date, retrospectively and for reporting purposes; it is not the number anybody dealt at |

Read the table as a warning about pronouns. When a document says "NAV", the first question is which of these the drafter meant, because the fee base, the redemption right, the loan covenant and the tax computation can each be attached to a different one.

## Who produces the number: manager, administrator, valuer

Three roles recur in every fund structure, and they are not interchangeable. Before comparing them, it helps to see what each one actually signs up to.

| **Role** | **What it does** | **What it does not do** | **Core conflict** |
| --- | --- | --- | --- |
| Manager (AIFM / adviser) | owns the valuation policy, supplies or approves Level 3 marks, bears legal responsibility for proper valuation | cannot contract out of responsibility by hiring a valuer | fees, performance and fundraising all rise with NAV |
| Administrator | computes NAV arithmetically from prices fed to it under the fund's policy; keeps the register | does not independently opine on the fairness of Level 3 marks unless contracted to | paid by the fund the manager controls; incentive to keep the mandate |
| External / independent valuer | values designated assets or verifies the process; provides professional guarantees | does not calculate the fund's NAV or replace the manager's responsibility | appointed and paid at the manager's initiative; scope set by engagement letter |
| Depositary | oversees that unit value is calculated in compliance with law, fund rules and the valuation procedures; escalates and requires remedial action | does not set marks and does not certify that a Level 3 valuation is correct | appointed by the manager, and dependent on the same client relationships it polices |
| Auditor | opines on the annual financial statements, including whether fair value measurement follows the accounting framework | does not opine on the monthly or daily dealing NAV that investors actually transacted at | works from management's models and assumptions; engaged by the entity it audits |

The table's practical message: "independently administered" and "independently valued" are different claims, and neither means the manager is out of the loop on the marks that matter most.

The EU regime is the most explicit about how this must be organised. Under AIFMD Article 19, valuation must be performed either by an **external valuer** — a person independent of the AIF, the AIFM and their close links, subject to mandatory professional registration and able to provide professional guarantees — or by the **AIFM itself**, provided the valuation task is functionally independent from portfolio management and the remuneration policy mitigates conflicts (Art 19(4)–(5)). The external valuer may not delegate the function onward (Art 19(6)); the depositary may only take the role if functionally and hierarchically separated (Art 19(4)); and valuation must be performed "impartially and with all due skill, care and diligence" (Art 19(8)). Two liability rules complete the design: the AIFM remains responsible for proper valuation and NAV calculation *even when it appoints an external valuer*, and the external valuer is liable to the AIFM for losses caused by its negligence or intentional failure, irrespective of any contract saying otherwise (Art 19(10)).

Level 2 fills in the process: a written valuation policy covering inputs, models and selection criteria for pricing sources, with prices from independent sources wherever possible (CDR 231/2013 Art 67); no investment in a new asset type until a methodology for it exists (Art 67(1)); models validated before use by someone with expertise who did not build them, and approved by senior management (Art 68); annual policy review (Art 70); and a mandatory heightened review of individual values where risk is elevated — single-broker quotes, illiquid exchange prices, marks influenced by related parties or by anyone with a financial interest in performance (Art 71(2)).

The US mutual-fund answer runs through governance rather than an external professional. SEC Rule 2a-5 (adopted December 2020) requires fair value determinations — mandatory whenever market quotations are not "readily available", meaning no unadjusted quote in an active market — to be made in good faith by the fund's board, or by a **valuation designee**, typically the adviser, under board oversight with periodic and prompt reporting, assessment of valuation risks, testing of methodologies and oversight of pricing services; Rule 31a-4 adds the record-keeping. For private funds advised by SEC-registered advisers there is no equivalent of Article 19: valuation discipline comes from the adviser's fiduciary duty, the fund documents, auditors — and enforcement.

Enforcement shows what the rules are for. In 2022 the SEC charged the founder of Infinity Q with overvaluing the assets of a mutual fund and a hedge fund by more than $1 billion: he altered the inputs and code of a third-party pricing service used to mark complex swaps, created backdated minutes of valuation meetings that never happened, and sent forged term sheets to the auditor. During the COVID volatility of 2020 the funds' actual value was roughly half the stated value; redemptions were halted in February 2021 and the funds liquidated. The lesson is not that third-party pricing fails — it is that a pricing service configured by the person it is meant to check is not independent at all.

## Who checks the checker: depositary, auditor and the limits of oversight

Two further parties sit above the valuation chain, and investors routinely credit both with more than they do.

The **depositary** is the only actor with a standing legal duty to look at somebody else's NAV. In the EU that duty sits at level 1 in AIFMD Article 21(9)(b) and is spelled out in Article 94 of Commission Delegated Regulation (EU) 231/2013, headed "Duties regarding the valuation of shares/units". The depositary must "verify on an ongoing basis that appropriate and consistent procedures are established and applied for the valuation of the assets of the AIF", must "ensure that the valuation policies and procedures are effectively implemented and periodically reviewed", and must run its own checks "at a frequency consistent with the frequency of the AIF's valuation policy". Then the operative sentence: where the depositary considers that the calculation of the value of the shares or units "has not been performed in compliance with applicable law or the AIF rules", it must notify the AIFM and "ensure that timely remedial action is taken in the best interest of the investors in the AIF" (Art 94(3)). Where an external valuer has been appointed, the depositary checks that the appointment itself complies (Art 94(4)). The UK carried the same article across on exit and re-pointed it at rule 3.11.25(2) of the FCA's Investment Funds sourcebook, so a UK AIF depositary owes the identical duty in domestic form.

Read the verbs, because they mark the boundary. The depositary verifies that a *process* exists, is applied and is reviewed; it escalates when the *calculation* does not comply with law or the fund rules. Nowhere is it asked to certify that a particular Level 3 mark is the right number — and it could not, having neither the mandate nor, usually, the models. The next article makes the contrast plain: Article 95 requires the depositary to monitor the AIF's compliance with investment restrictions and leverage limits and to operate an escalation procedure when they are breached. A limit is testable against a rulebook. The fairness of a mark is not.

The liability picture points the same way. A depositary is liable for the loss of financial instruments held in its custody unless it proves the loss arose from an external event beyond its reasonable control, while for other losses it answers only on intent or negligence (AIFMD Art 21(12)). That asymmetry is why the depositary regime is a strong protection against assets disappearing and a weak one against assets being mispriced. What custody does and does not cover is an institution in its own right — see [what a depositary actually holds and what it merely records](https://wiki.private.law/en/securities-custody).

The **auditor** is annual, retrospective and framework-bound. An audit opinion addresses whether the financial statements give a true and fair view under the applicable accounting framework, which includes whether fair value measurement follows it — not whether the dealing NAV investors transacted at during the year was right. Some regimes give the auditor an explicit role inside the error machinery: Chapter 8 of Circular CSSF 24/856 sets out what Luxembourg's *réviseurs d'entreprises agréés* must do about NAV calculation errors and investment-rule breaches. Even there, the auditor sees the year, not the dealing day.

**One rulebook, and a court that removed it.** The United States tried to add by regulation much of the layer the EU takes for granted, and lost. In *National Association of Private Fund Managers v. Securities and Exchange Commission* (US Court of Appeals for the Fifth Circuit, 5 June 2024, No. 23-60471) the court reviewed the SEC's Private Fund Adviser Rules, adopted on 23 August 2023, which would have required registered private fund advisers to send investors quarterly statements of fees, expenses and performance, to obtain and distribute an annual financial statement audit of each private fund they advise, and to obtain "a fairness opinion or valuation opinion" in connection with an adviser-led secondary transaction. The court held that section 211(h) of the Advisers Act, on which the Commission relied, belongs to a Dodd-Frank provision directed at *retail customers* and does not reach private fund investors, and that section 206(4) could not carry the weight either: the Commission had not defined the fraudulent conduct before prescribing means reasonably designed to prevent it, the misconduct it pointed to involved roughly 0.05% of advisers, and section 206(4) does not authorise the disclosure and reporting requirements Congress addressed elsewhere. The disposition was total — "Accordingly, we VACATE the Final Rule." The consequence for valuation is precise: in a US private fund, an annual audit and an independent valuation opinion on a GP-led secondary are matters of the fund documents and of investor bargaining power, not of federal rule.

## When the number is wrong: NAV errors and restatement

A NAV error is not an exotic event; the EU regime simply assumes it will happen and requires the AIFM to have remedial procedures for an incorrect NAV calculation (CDR 231/2013 Art 72(3)). What remediation means in practice is set by national regulation, fund domicile guidance and the fund's own documents, and typically distinguishes three questions: was the error material (jurisdictional practice commonly uses tolerance thresholds graduated by fund type); who dealt at the wrong price (subscribers who overpaid and redeemers who were underpaid are compensated — and, symmetrically, the fund may be owed money by those who benefited); and must past NAVs be restated and investors notified. The uncomfortable feature of restatement is temporal: the people harmed by an overstated NAV are often no longer in the fund by the time it is corrected, and the people paying for the correction are whoever remains.

### Materiality thresholds and who gets paid back

"Material" is not left to taste in the large fund domiciles; it is a number, and the number depends on what the fund holds. Luxembourg publishes the most explicit version. Circular CSSF 24/856, published on 29 March 2024 and applicable from 1 January 2025, repealed and replaced the 2002 Circular CSSF 02/77 and fixes the tolerance thresholds below which a NAV calculation error is not treated as significant.

| **Fund type (Circular CSSF 24/856, point 35)** | **Tolerance threshold, % of NAV** |
| --- | --- |
| Money market fund governed by the MMFR | 0.20% |
| UCITS investing primarily in bonds, and mixed UCITS | 0.50% |
| UCITS investing primarily in shares ("equity UCIs"), and UCITS in other eligible assets | 1.00% |
| Part II UCIs and ELTIFs open to non-professional investors | 0.50% bond and mixed, 1.00% equity and other assets; above 1% only on a documented analysis |
| SIFs, SICARs, EuVECAs, EuSEFs and UCIs reserved to well-informed investors | set by documented analysis, capped at 5% of NAV |

The thresholds are a switch, not a licence. Below one, the circular treats it as enough "to correct the source of the error that occurred and to take all necessary measures to prevent such an error from reoccurring in the future" (point 33). Above it the error is significant: corrected NAVs, an impact assessment and compensation without delay (point 40), notified on the forms the CSSF issued in December 2024 — although closed-ended UCIs "do not have to notify any NAV calculation errors covered by Chapter 4 to the CSSF" (point 27), because nobody dealt at the wrong price. Which domicile a fund sits in therefore changes what an identical mistake costs, and that is part of what a [choice of fund domicile](https://wiki.private.law/en/fund-domicile-jurisdictions) is buying.

**Two systems, one overpayment.** Whether money already paid out can be recovered is not a regulatory question at all in the offshore fund world — it is a contractual one, and the leading authority answers no. In *Fairfield Sentry Ltd (in Liquidation) v Migani* (Judicial Committee of the Privy Council, 16 April 2014, \[2014\] UKPC 9, on appeal from the British Virgin Islands) the liquidators of a Madoff feeder fund sued redeemed investors to recover redemption proceeds paid on NAVs that were fictitious, because the underlying portfolio did not exist. The Board held that under the fund's articles the redemption price was the NAV *as determined by the directors at the time of redemption*; that documents routinely sent to investors — a monthly email, a monthly statement of account, the contract note sent to a redeeming client — could constitute the binding certificate of that determination; and that no restitutionary claim lay, because "a payee of money is not unjustly enriched if he was entitled to receive the sum paid to him". The investors kept the money. Set the two systems side by side and the design choice is visible: Luxembourg makes the fund pay the harmed cohort under a supervisory circular, while BVI leaves the loss where the fund's own documents put it, which is on whoever still holds units. A clawback in a [Cayman or BVI fund vehicle](https://wiki.private.law/en/cayman-fund) has to be written into the articles before the error, not argued after it.

## Dealing at NAV — and why NAV is not cash

In an open-ended fund the **dealing price** at which investors subscribe and redeem is derived from NAV, but it is not automatically equal to it. Funds deduct redemption fees, apply swing pricing or dual pricing to charge transaction costs to the investors who cause them, and reserve anti-dilution levies — all mechanisms whose declared purpose, in the EU legislative definitions, is to ensure that investors who remain in the fund "are not unfairly disadvantaged" by those who move (Directive (EU) 2024/927, Annex V).

The deeper constraint is the **liquidity mismatch**. NAV measures value; redemption requires cash. A fund whose assets take months to sell but whose investors can exit monthly has promised a conversion speed its portfolio cannot deliver. EU law names this directly: an AIFM must run a liquidity management system, stress-test under normal and exceptional conditions, and ensure the investment strategy, liquidity profile and redemption policy are *consistent* (AIFMD Art 16). Investors must also be told, periodically, what percentage of the fund's assets is subject to special arrangements arising from their illiquid nature (Art 23(4)).

The UK produced the canonical failure. The LF Woodford Equity Income Fund — a daily-dealing authorised fund holding a growing share of illiquid and unquoted positions — was suspended on 3 June 2019 and never reopened. The FCA's findings against Link Fund Solutions, the fund's authorised corporate director, were that between 31 July 2018 and the suspension it failed to manage the fund's liquidity so investors could access their money at short notice, failed to properly oversee the investment manager, and breached Principles 2 (skill, care and diligence) and 6 (fair treatment of customers); a redress scheme of up to £230 million was approved by the High Court in February 2024. The mechanics matter more than the personalities: while the fund stayed open, redemptions were paid from the liquid end of the portfolio, so each departing investor left the survivors holding a portfolio that was smaller and *less* liquid — the classic first-mover advantage of an open-ended fund with illiquid assets.

## The dealing cut-off: forward pricing, late trading and market timing

Every open-ended fund has a time of day after which an order stops being today's business. That line — the cut-off — carries far more legal weight than its administrative appearance suggests, because it is what stops someone who already knows how the market closed from buying a price struck before it did.

The US rule states the principle as a prohibition on whoever takes the order. Under Rule 22c-1(a) (17 CFR 270.22c-1) a registered investment company, the persons authorised to consummate transactions in its shares, and any principal underwriter or dealer may not sell, redeem or repurchase a redeemable security "except at a price based on the current net asset value of such security which is next computed after receipt of a tender of such security for redemption or of an order to purchase or sell such security". That is forward pricing in one sentence: you deal at a number that does not exist yet. Rule 22c-1(b)(1) fixes the rhythm — NAV "shall be computed no less frequently than once daily, Monday through Friday, at the specific time or times during the day that the board of directors of the investment company sets".

Luxembourg names the two abuses the cut-off exists to prevent. Circular CSSF 04/146 of 17 June 2004 defines **late trading** as "acceptance of a subscription, conversion or redemption order after the time limit fixed for accepting orders (cut-off time) on the relevant day and the execution of such order at the price based on the net asset value (NAV) applicable to such same day". The cut-off must be fixed so as to precede or coincide with the moment the NAV is calculated, and orders arriving after it must be executed at the next applicable NAV. This is not a grey area: the circular treats late trading as unacceptable because it violates the fund's own prospectus. **Market timing** is defined as "an arbitrage method through which an investor systematically subscribes and redeems or converts units or shares of the same UCI within a short time period, by taking advantage of time differences and/or imperfections or deficiencies in the method of determination of the NAV".

That second definition is the defect from the Level 3 discussion wearing different clothes. Market timing needs no unobservable input: a fund holding Tokyo-listed equities is priced off a market that closed hours before the dealing point, so a Level 1 quote can be exactly as stale as a private loan carried at cost — and stale in a direction the arbitrageur can already see. The answer is the same too: a valuation that overrides the quote. Where a significant event has made the last quotation unrepresentative, the quotation is no longer "readily available" and a fair value determination is required under SEC Rule 2a-5, which is why fair-value pricing of foreign holdings is an anti-dilution control and not an accounting nicety.

> 💡 Change one fact — four minutes. Meridian's cut-off and valuation point are both the 16:00 close. Investor C's redemption instruction reaches the administrator at 15:58 and is dealt at today's NAV. Move it to 16:02: the order rolls to the next dealing point and carries the intervening market risk — which, if bad news breaks at 17:00, is precisely the risk the earlier investor escaped. Nothing about the investor changed and nothing about the portfolio changed; the only variable was a timestamp. Accepting that 16:02 order at today's price would be late trading under Circular CSSF 04/146 and a pricing breach under Rule 22c-1(a), and the amount the late dealer avoids is the amount the remaining investors pay. That is why the cut-off is enforced as an integrity rule and not as an operational convenience.

For the investor the practical consequence sits in the subscription paperwork rather than in the statute. The cut-off, the valuation point, the settlement period and the identity of the entity that must actually receive the instruction are all defined in the fund's documents and in the [onboarding and dealing mechanics](https://wiki.private.law/en/investor-onboarding) — and an instruction that reaches a distributor by the cut-off has not necessarily reached the fund.

## The liquidity toolkit: gates, suspension, side pockets

When the mismatch bites, the response comes from a defined toolkit. Since Directive (EU) 2024/927 (transposition deadline 16 April 2026), EU law lists the tools in Annex V and requires every manager of an open-ended AIF to select at least two of them (from gates, notice-period extension, redemption fees, swing pricing, dual pricing, anti-dilution levy, redemption in kind — and not swing pricing and dual pricing alone), write them into the fund rules with activation procedures, and notify its regulator; suspension and side pockets remain available in exceptional circumstances regardless of the selection.

| **Tool** | **Mechanism (Annex V definition)** | **Who bears the cost** |
| --- | --- | --- |
| Redemption gate | temporary, partial restriction — investors can redeem only a portion of their units | exiting investors wait; remaining investors protected from fire sales |
| Suspension | subscriptions and redemptions temporarily disallowed | everyone waits; no cohort trades on a wrong price |
| Extended notice period | longer warning before redemption is executed | exiting investors carry market risk during notice |
| Redemption fee / anti-dilution levy | charge reflecting the cost of liquidity, paid to the fund | exiting (or transacting) investors pay; the fund is compensated |
| Swing / dual pricing | dealing price adjusted by a liquidity-cost factor | transacting investors pay; NAV of remaining holders undistorted |
| Redemption in kind | assets transferred instead of cash | exiting investor takes the liquidity problem with them |
| Side pocket | assets whose economic or legal features have become uncertain are separated from the main fund | all holders at separation keep pro-rata exposure to the frozen slice; the liquid remainder deals normally |

Read down the third column and the toolkit resolves into a single design question: every tool is an answer to who should pay for liquidity — the investor who demands it, or the investors who stay.

In the UK, suspension of an authorised fund is governed by FCA rules: the authorised fund manager may suspend dealings with the prior agreement of the depositary — and must, if the depositary requires it — only where exceptional circumstances make it in the interests of all unitholders (COLL 7.2.1R); the FCA must be notified immediately with reasons, the suspension must be formally reviewed at least every 28 days, and it must end as soon as the exceptional circumstances have passed. For funds investing in immovables, suspension becomes mandatory when the standing independent valuer expresses material uncertainty over 20% or more of the scheme property. And in 2022 the FCA showed how a regulator can extend the toolkit: policy statement PS22/8 allowed retail authorised funds holding Russian assets that [sanctions had made unsaleable or impossible to value](https://wiki.private.law/en/sanctions-map) to create **side pockets** — separate unit classes quarantining the affected assets — so that the liquid remainder could resume dealing, new investors would not buy into the frozen exposure, and existing investors kept their claim on any eventual recovery. Use of the side pocket was the manager's option, not an obligation.

> 🍓 Every liquidity tool re-divides one fixed loss between two groups: those leaving and those staying. Gates and suspension slow the leavers to protect the stayers; swing pricing and levies charge the leavers; side pockets freeze the disputed slice for everyone who held it on the day. None of the tools creates value — they only decide who waits and who pays.

## Who bears the loss: four scenarios

The scenarios below use one fictional fund so that a single variable can be changed at a time. All numbers are invented for illustration. *Meridian Credit Fund*: open-ended, quarterly dealing, NAV $200 million across 1,000,000 units ($200.00 per unit). The portfolio: $160m of tradable bonds and cash, plus a $40m private loan to a single borrower, marked at cost. Investor A holds 50,000 units (5%). Assume the borrower has deteriorated toward [default](https://wiki.private.law/en/cross-border-insolvency) and a current fair value of the loan is $28m — a $12m loss that exists economically but has not yet entered NAV.

> 💡 Scenario 1 — stale valuation meets an open dealing day (fictional). Investor A redeems all 50,000 units at the stale NAV of $200.00 and is paid $10.0m in cash. The loss is recognised the following week: NAV falls to $178m over 950,000 remaining units — $187.37 per unit. Now change one variable: the write-down is booked *before* the dealing day. NAV per unit becomes $188.00; Investor A receives $9.4m, and remaining investors also hold units worth $188.00. The $600,000 difference is a pure transfer from remaining investors to the exiting one, created entirely by the sequencing of loss recognition and dealing. Investor A's contractual right (redemption at the published dealing price) was identical in both runs; what moved the money was the manager's valuation timing — which is why CDR 231/2013 Art 74 requires revaluation whenever evidence shows the last value is no longer fair, and why deliberately delaying a write-down past a dealing day is not a valuation judgment but a treatment-of-investors problem a regulator can act on.

**Scenario 2 — exit before loss recognition, at scale.** The Woodford pattern is Scenario 1 repeated daily for months. Each redemption was contractually valid and paid at the published price; the manager's decisions — keep the fund open, meet redemptions from the liquid sleeve, reclassify and restructure illiquid positions rather than write them down or gate — progressively concentrated illiquidity on those who stayed. The regulatory boundary was crossed not by any single redemption but by the failure to manage liquidity and treat customer cohorts fairly, which is what the FCA's £230m redress scheme priced. Contractual right, manager conduct and regulatory duty gave three different answers to the same facts — which is exactly why all three must be checked separately.

**Scenario 3 — gate, then suspension (fictional).** Meridian's documents allow a 10% quarterly gate. Redemption requests arrive for 25% of units. The *contract* gives the manager the power, not the duty, to gate: activating it is a manager decision, taken under the fund's stated procedures and (in the EU from 2026) notified to the regulator. Gated investors are prorated — each redeems 40% of their request — and the balance rolls to the next dealing day, still exposed to the fund's performance. If the position deteriorates into exceptional circumstances, suspension stops everyone: no cohort deals on a price the manager cannot stand behind. The regulatory boundary runs on both sides — a UK authorised fund manager needs depositary agreement and FCA notification to suspend (COLL 7.2.1R), but a manager who *fails* to suspend when dealing prices have become unreliable is choosing to let some investors trade on a wrong number.

**Scenario 4 — secondary sale at a discount (fictional).** Investor B holds a closed-ended fund interest with a reported NAV of $10m and no redemption right at all. A [secondary buyer](https://wiki.private.law/en/fund-secondaries) offers 82 — $8.2m. Nothing is "wrong" with either number: NAV is the manager's fair-value estimate of the portfolio; 82 is the price of immediate cash, reflecting the buyer's return target, the unfunded commitment they assume, and their scepticism about the marks. The economic effect stays with the seller alone — remaining LPs are untouched, because the fund itself paid nothing. That containment is the structural virtue of closed-ended funds: liquidity risk is transferred person-to-person on the secondary market instead of being extracted from the common pool. The transaction still needs GP consent under the [LPA's transfer provisions](https://wiki.private.law/en/lpa-mechanics), and the discount, not NAV, is the number that measures what the interest was worth that day.

## Valuation workflow

The process the rules add up to, end to end:

1. **Policy before investment** — written valuation policy identifying a methodology for every asset type; no first investment in a new type without one (CDR 231/2013 Art 67).
2. **Input selection** — pricing sources chosen by documented criteria, independent wherever possible; hierarchy of observable over model inputs.
3. **Model control** — models documented, justified, validated by someone who did not build them, approved by senior management (Art 68).
4. **Marking** — positions valued at the required frequency: every NAV calculation for financial instruments in open-ended funds; at least annually, and on evidence of unfairness, for the rest (Art 74).
5. **Heightened review** — single-source, related-party, illiquid and model-sensitive marks tested against realised prices, third-party values, stale-price checks (Art 71).
6. **NAV computation** — administrator applies prices, accruals, fees and unit count; NAV per unit calculated at each issue and redemption, at least annually (Art 72).
7. **Approval and publication** — sign-off under the governance model in use: functionally independent internal function, external valuer, or (US registered funds) board or valuation designee under Rule 2a-5.
8. **Error remediation** — detection, materiality assessment, compensation of affected dealers, restatement and notification per the fund's remedial procedures (Art 72(3)).
## Consequence matrix

The matrix compresses the article into one question per row: when this event happens, who decided, under what authority, and which cohort pays.

| **Event** | **Who decides** | **Legal basis** | **Exiting investors** | **Remaining investors** |
| --- | --- | --- | --- | --- |
| Stale mark carried into a dealing day | manager (valuation timing) | valuation policy; Art 74 duty to update | overpaid (falling market) | absorb the unrecognised loss |
| NAV error found and restated | manager + administrator; regulator informed per domicile rules | remedial procedures, Art 72(3) | compensated or clawed back | bear cost or receive recovery via the fund |
| Gate activated | manager, within documented limits | fund rules; Annex V pt 2; regulator notified | prorated, wait in the queue at market risk | protected from forced sales |
| Suspension | manager with depositary; regulator may require or end it | COLL 7.2 (UK); Art 16 / Annex V pt 1 (EU) | frozen with everyone else | frozen; no first-mover drain |
| Side pocket created | manager (optional), under regime conditions | Annex V pt 9; FCA PS22/8 model | keep frozen slice pro-rata; liquid part redeemable | same as exiting — the split is by asset, not by cohort |
| Secondary sale at discount | selling investor + buyer; GP consent to transfer | LPA transfer clause; sale contract | realise the discount personally | unaffected; fund pays nothing |
| Order accepted after the cut-off at today's price | whoever takes the order — distributor, administrator — and the manager's controls | Rule 22c-1(a) forward pricing; Circular CSSF 04/146 (late trading) | late dealer captures a price they were not entitled to | pay for it unit for unit; the fund is diluted |
| Depositary finds unit value was not calculated in compliance | depositary escalates; manager must remediate | CDR 231/2013 Art 94(3); rule 3.11.25(2) of the Investment Funds sourcebook in the UK | compensated if the error crosses the domicile's threshold | protected going forward; may fund the correction |

The pattern across rows: the further an event moves from contract (row 6) toward discretion (rows 1–5), the more the outcome depends on process quality — valuation governance, liquidity management, and the regulator's willingness to police the boundary. Where the fund's tax position also turns on NAV timing — fee offsets, carried interest crystallisation — the [fund's tax architecture](https://wiki.private.law/en/fund-tax-architecture) reads these same events differently, and a manager's [regulatory perimeter](https://wiki.private.law/en/fund-regulatory-perimeter) determines which of the rules above apply to it at all.

## Q/A

### Is a fund legally obliged to redeem me at NAV?

Only if, and as far as, its documents say so. Open-ended funds typically promise dealing at a NAV-derived price subject to gates, suspension powers, fees, notice periods and swing pricing in the same documents. Closed-ended funds give no redemption right: exit is by distribution or by selling the interest at a market price, which normally differs from NAV.

### Who is legally responsible if the NAV is wrong?

Under AIFMD Article 19(10) the manager remains responsible for proper valuation and NAV calculation even where an external valuer is appointed; the external valuer is in turn liable to the manager for negligent or intentional failure, regardless of contrary contract terms. The administrator's responsibility is defined by its service agreement — usually computation, not opinion on marks. In the US registered-fund context, Rule 2a-5 places fair value determination with the board or its valuation designee.

### Does an independent administrator guarantee honest valuations?

No. An administrator ordinarily applies the fund's valuation policy to prices supplied or approved under it; for Level 3 assets those prices originate with the manager or its chosen sources. Infinity Q had third-party pricing and an auditor — the founder altered the pricing service's inputs and forged documents, and the SEC alleged over $1 billion of overvaluation. Independence matters at the point where the mark is made, not just where it is added up.

### Can the manager simply refuse to update a valuation before a dealing day?

The discretion is narrower than it looks. EU rules require revaluation whenever there is evidence that the last value is no longer fair (CDR 231/2013 Art 74) and require stale-price testing (Art 71). A manager who deals at a price it knows to be stale is exposed on fair-treatment and valuation-process grounds, not protected by the absence of a market quote.

### Is a gate or suspension a breach of my rights?

Usually the opposite: gates and suspension powers are in the fund documents you subscribed to, and regulation frames them as investor-protection tools. In the UK, suspension requires exceptional circumstances, depositary agreement, immediate FCA notification and review at least every 28 days (COLL 7.2). The right question is not whether the tool is legal but which cohort it protects — and whether it was activated in time.

### If the fund's NAV equals its true value, can I always get my money?

No. NAV measures value; redemption requires cash or saleable assets. A correctly valued fund holding illiquid assets can still gate or suspend because it cannot convert value into cash at the promised speed. That is why EU law requires the investment strategy, liquidity profile and redemption policy to be consistent (AIFMD Art 16) — the promise of exit has to match the portfolio, not just the price.

### What happens to investors who redeemed before a NAV error was discovered?

It depends on the fund's remedial procedures and domicile practice. If they were overpaid because NAV was overstated, the fund may have a claim to recover the excess, but recovery from departed investors is often impractical — which is why the cost of an error typically lands on remaining investors, and why materiality thresholds and compensation rules are worth reading before subscribing.

### Why would I sell at 82% of NAV instead of waiting for distributions?

Because the discount prices time, risk and the unfunded commitment the buyer assumes. NAV is the manager's estimate of what the portfolio is worth in orderly conditions; the secondary price is what immediate liquidity costs today. In a closed-ended fund with years to run, the seller pays that cost personally — remaining investors are unaffected, which is precisely how closed-ended structures contain liquidity risk.

### I sent my redemption instruction at 16:02. Which price do I get?

The next one. Forward pricing means you deal at a NAV computed after your order arrives: Rule 22c-1(a) requires a price based on the net asset value "next computed after receipt", and Circular CSSF 04/146 requires orders received after the cut-off to be executed at the next applicable NAV, treating same-day execution as late trading. Check three things in the fund documents — the cut-off time, the valuation point, and which entity must physically receive the instruction, because reaching a distributor is not always reaching the fund.

### The fund has restated its NAV downwards. Can it demand money back from me?

That depends on the fund's documents and its domicile, not on fairness. In Luxembourg a significant error triggers the compensation machinery of Circular CSSF 24/856 in both directions, and well-informed or professional investors may be asked to return an undue gain. In the offshore contractual world the leading authority runs the other way: in *Fairfield Sentry Ltd (in Liquidation) v Migani* the Privy Council held that a redemption paid on a NAV determined by the directors at the time of redemption is irrecoverable, because "a payee of money is not unjustly enriched if he was entitled to receive the sum paid to him" — even where the underlying portfolio never existed.

### Isn't the depositary responsible for checking the NAV?

For the process, yes; for the mark, no. Article 94 of CDR 231/2013 requires the depositary to verify on an ongoing basis that valuation procedures exist and are applied, and, where the calculation of unit value does not comply with law or the fund rules, to notify the manager and ensure timely remedial action in the investors' interest. It is not asked to opine that a particular Level 3 valuation is correct. Its hardest liability runs to the loss of financial instruments held in custody (AIFMD Art 21(12)) — a different failure entirely, covered under [custody and the depositary's duties](https://wiki.private.law/en/securities-custody).

### My fund holds assets that sanctions made impossible to sell. What happens to my NAV?

Typically the asset is quarantined rather than valued. That is what the FCA's PS22/8 side pocket model does: the affected holdings move into a separate unit class, the liquid remainder resumes dealing, and holders on the day of separation keep their pro-rata claim on any eventual recovery. The alternative — leaving an unvaluable asset inside a dealing NAV — means every subscription and redemption happens at a number nobody can stand behind, which is normally a reason to suspend rather than to keep dealing.

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## Factual claims

- That last point names the central defect of Level 3 portfolios: stale pricing.
- A NAV error is not an exotic event; the EU regime simply assumes it will happen and requires the AIFM to have remedial procedures for an incorrect NAV calculation (CDR 231/2013 Art 72(3)).
- That second definition is the defect from the Level 3 discussion wearing different clothes.
- Scenario 2 — exit before loss recognition, at scale.
- Scenario 3 — gate, then suspension (fictional).
- Scenario 4 — secondary sale at a discount (fictional).
- The matrix compresses the article into one question per row: when this event happens, who decided, under what authority, and which cohort pays.

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