11th February 2009

Dear Investor,

What is an asset worth?

One of the key items to consider when evaluating the financial reports of potential investments is how the values of assets have been determined. Under the International Accounting Standards used in Australia, assets are recognised using one of three methods:

  • Cost (referred to as "amortised cost" or "held to maturity");
  • Market value with realised and unrealised gains recognised in the Profit & Loss "P&L" (referred to as "designated at fair value" or "held for trading"); or
  • Market value with unrealised gains recognised in equity and realised gains recognised in the P&L (referred to as "available for sale").

Use of the cost method is restricted to assets which have a finite life, such as loans and receivables. Transaction costs incurred in acquiring these assets are capitalised and amortised over the life of the asset. This is the method used by La Trobe in valuing the assets of the La Trobe Australian Mortgage Fund.

Use of market values

For assets traded on active markets, such as shares on the ASX, market value is based on the last bid price in the relevant market. For other assets, values are determined by reference to valuation models, which may involve independent valuers e.g. real estate valuers. As with any model, it is important to understand the appropriateness, sensitivities and importance of the key assumptions that underpin the valuation model. For instance, a model for an investment in a toll road, may have interest rates, traffic volumes and expected toll price increases as the key assumptions. As an investor, the question is how appropriate are the model and assumptions used. This is what the recent commotion in the press about the values of "alternative assets" held by large industry superannuation funds is about. Where it is impracticable to construct a model, say due to an asset's uniqueness, then accounting standards permit the use of cost as a substitute for market value.

Market value volatility

With the Global Financial Crisis, share prices have collapsed and as most managed funds and superannuation funds use the "held for trading" approach, the reduced share prices have resulted in significant losses being recorded in P&Ls. This demonstrates the fundamental consequence of the "held for trading" method as the P&L is subject to significant volatility, as asset prices fluctuate. One valid criticism of the "held for trading" method is that it can be difficult to assess the performance of management as the true test is knowing when to sell assets in a portfolio (ie what is the realised profit). Some entities do not disclose the realised/unrealised gain split, which makes this assessment difficult. It is akin to saying, that you only really have made a profit from renovating your house when you sell it, not because your neighbour has sold their house at a high price reflecting high property values.

Whilst the "available for sale" method addresses the issue of P&L volatility, the net assets are still subject to change and for many funds the use of net asset values is key for both determining entry/exit prices and management fees.

Immunity from losses

It is important to note that regardless of whether a market value method or the amortised cost method is used, there is always a risk in holding an asset that it may be subject to loss. Whilst the potential for loss may be factored into market prices, all assets are required under accounting standards to be reviewed for impairment and a provision recognised where appropriate.

Comparing the methods

As an example of the contrast between the three methods, we can examine a two year investment of $100 in a Government bond paying a fixed return of 6%p.a. where market interest rates drop from 6% to 4% at the end of the first year. The three different methods will result in different outcomes when determining the value of an asset returning 6%p.a. compared to a current market return of 4%p.a. as follows;

Best regards,
Chris Andrews


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Chris Andrews
Head of Funds Management

t  +61 3 8610 2811
e  candrews@latrobefinancial.com.au

Chris Andrews is the Head of Funds Management for the La Trobe Group and has responsibility for the La Trobe Australian Mortgage Fund.
Read full profile here.

La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 115 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.

Copyright 2010 La Trobe Financial. All rights reserved. No portion of this may be reproduced, copied, or in any way reused without written permission from La Trobe Financial. Disclaimer

* La Trobe Financial Asset Management Limited ABN: 27 007 332 363 and AFSL No: 222213 is the issuer and manager of the La Trobe Australian Mortgage Fund. It is important for you to read the Product Disclosure Statement for the Fund before you make any investment decision. You can get a copy of the PDS by calling 1800 818 818. You should consider carefully whether or not investing in the Fund is appropriate for you.
(1) The rates of return from the Fund are not guaranteed and are determined by future revenue of the Fund, and may achieve lower than expected returns. Past performance is no guarantee of future performance. Investors risk losing some or all of their principal investment.
(2) Withdrawal rights are subject to liquidity and may be delayed or suspended.
(3) As at 30/11/10 the La Trobe Australian Mortgage Fund had received a Morningstar RatingTM of 5 stars. The Morningstar Rating is an assessment of a fund's past performance - based on both return and risk - which shows how similar investments compare with their competitors. A high rating alone is insufficient basis for an investment decision. © 2010 Morningstar, Inc. All rights reserved. Neither Morningstar, nor its affiliates nor their content providers guarantee the above data or content to be accurate, complete or timely nor will they have any liability for its use or distribution. Any general advice has been prepared by Morningstar Australasia Pty Ltd ABN: 95 090 665 544, AFSL: 240892 (a subsidiary of Morningstar, Inc.), without reference to your objectives, financial situation or needs. You should consider the advice in light of these matters and, if applicable, the relevant product disclosure statement, before making any decision. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/fsg.pdf
(4) 3.75 star rating out of a possible 5 star rating indicates that Adviser Edge believes that La Trobe has performed in line with its peers and exceeded its peers on some fronts.
(5) The Standard and Poors rating of 4 out of 5 stars indicates that S + P has high conviction that La Trobe Financial will consistently generate risk-adjusted fund returns in excess of its relevant investment objectives and relative to its peers.
(6) The award was given to the La Trobe Australian Mortgage Fund, Pooled Mortgages Option.
Research Ratings are subject to change. To view the latest research information please visit www.adviseredge.com.au or www.standardandpoors.com.au. Ratings issued by Adviser Edge Investment Research AFS Licence No. 236783 and Standard & Poors Information Services (Australia) Pty Ltd AFS Licence No. 258896 are solely statements of opinion and not statements of fact or recommendations to purchase, hold, or sell any securities or make any other investment decisions. The ratings are only one factor to be taken into account in deciding to invest. Research Houses receive a fee from La Trobe for rating the product. The Adviser Edge rating is generally a measure of the rated entity's capacity to meet its repayment obligations in all market circumstances.
IMPORTANT: This message, together with the La Trobe Financial website (www.latrobefinancial.com.au) and all its contents have been prepared for general information only and should not be taken as legal or financial advice, and as such the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore talk with their financial planner or advisor before acting on any information present on this message or the La Trobe website.