Fair Value Hierarchy GIPS
The fair value hierarchy (GIPS) establishes a hierarchy for what price to use when the market price of a security is not available. Market prices of a security may be unavailable because a security may be traded infrequently, transaction prices may not be reported, or because it is a private investment for which no transactions are occuring. On this page, we discuss the Global Investment Performance Standards fair value hierarchy, which has 4 levels.
Fair value hierarchy methods
The GIPS fair value hierarchy is defined in descending order of usage. Thus, a method lower in the hierarchy implies that it is only used when all methods higher in the hierarchy cannot be used because they are unavailable.
The hierarchy is defined as follows:
- Market price, e.g. for an actively traded stock or bond
- Quoted prices for less actively traded identical or very similar investments (e.g. the last available price for the security if there is no material evidence that the price would have changed)
- Market-based inputs to estimate the price (e.g. using the P/E or dividend yield for comparable and actively traded securities to infer a price estimate)
- Price estimates based on inputs that are not directly observable (e.g. a DCF price estimate based on projected cash flows and a discount rate).
Fair value for real estate and private equity
Finally, we note that in the case of real estate and private equity we will typically need to use methods that fall well down the valuation hierarchy. For these asset classes, GIPS has specified additional guidelines.
- Real estate valuation principles include rotating between external evaluators every few years and not allowing the valuator’s fee from depending on the estimated value.
- Private equity valuation principles require using the most appropriate method and taking into consideration the characteristics of the private enterprise being valued when choosing the method.
We discussed the GIPS fair value hierarchy used to value securities. It consists of 4 layers and should only be used if no market prices are available. In the case of real estate and private equity, GIPS specify additional guidelines in addition to the hierarchy outlined above.