Nothing gets the juices flowing like a discussion of accounting terms. Yet the accounting concept of mark to market has leapt onto the front pages after the demise of Silicon Valley Bank (“SVB”). Mark to market is a method of adjusting asset and liabilities to reflect their true market value.

SVB invested a surge of customer deposits in government sponsored mortgage bonds that were not due to mature for over 10 years. They did this instead of investing in short-term securities to try and earn a higher return. An extra return that in retrospect seems depressingly low after the implosion of the bank and a move up in interest rates.

There is little doubt that if the bank had been able to hold the bonds to maturity, they would have received all of their money back. They are after all backed by the US government. And accounting rules reflected that and stated that the bank didn’t need to recognise the losses as long as the bonds were not sold.

A reduction of deposits eventually forced the bank to sell off some of the bonds to give customers their money back. This sale forced the bank to recognise the losses which started a run on the bank as customers raced to pull their money out. This caused the bank to go under.

Headlines over the weeks and months ahead will highlight federal inventions to calm the market. There will be recriminations about poor regulation, stupid moves by management and auditors asleep at the switch. Yet the real lessons will likely be forgotten. And those lessons are not just for bankers. There are several things everyday investors can learn from this episode.

Cash matters

The talking heads are droning on about asset and liability mismatch. They are trying to use jargon to explain something that most of us intuitively understand. You’ve got a problem if you need cash right away and don’t have it. It means you need to start selling off your assets at whatever price you can get. It doesn’t really matter what something is worth in the future. It matters what you can get for it right now.

We are told that investing is simple. Just buy low and sell high. Central to this straightforward notion is the wherewithal and ability to avoid selling at a bad time. When the sale is being dictated, you have lost control over the situation and may have to sell at a very bad time.

We are also told that cash is a terrible investment. The return is low and often outpaced by inflation. The opportunity cost of not putting extra money in higher performing asset classes is profound. Yet there is a difference between investments and investing. Investing involves an appreciation of your own situation and setting yourself up for success.

An emergency fund prevents the unpredictability of life from dictating circumstances to you. I have an emergency fund that I continually build up and equals half of my pre-tax salary. Perhaps this is excessive, but it allows me to sleep at night. It gives me confidence that the shares I own can do what they do best and compound over the long-term. I will not be forced to sell because of unexpected expenses or job loss.

I’ve used the bucket approach for my retired mother with five years of her living expenses sitting in cash in the short-term bucket. Once again this might be excessive. But it means she will never be forced to sell her shares when the timing isn’t right.

At the end of day, the SVB incident is about greed. The management and board of the bank was greedy in the pursuit of extra returns. This wasn’t naked greed. They didn’t take the money to Vegas. And they didn’t steal it. But they ignored common sense because they assumed everything would work out. Many people do this with their own finances. Not having access to cash is the same thing when you are investing.

Your assumptions about bonds may not apply to the way you access the asset class

As interest rates tick higher bonds are becoming more attractive to investors. I previously mentioned the irony that SVB would have gotten the full value of the bonds back if they had the ability to hold them to maturity. And this is the mentality of many individual investors who buy bonds. It is true if you buy individual bonds. If the bond issuer does not default, you will get your principal back and whatever interest is paid. Simple as that. Mark to market is irrelevant if you hold to maturity.

That is not the case if you invest in a portfolio of bonds through an ETF or fund. When it comes to an ETF or fund the assets are marketed to market every single day. And there is no maturity to bail you out.

As interest rates rise bonds go down in value. A portfolio of bonds that is constantly getting new bonds added even as some mature will never reach a point where you get your principal back. That means - in theory - if interest rates continue to rise in perpetuity a bond ETF or fund will continue to go down in value.

Interest rates don’t go in a single direction forever. Yet since the last period of inflation ended in the 1980s they’ve moved steadily down with several fits and starts along the way. We hear a lot about how central banks will have to end the policy of interest rate rises in response to SVB. Maybe that is the case. Yet if inflation has not been put to rest I’m willing to bet they will eventually resume their climb. They might even have to go higher because of the pause if inflation is allowed to further embed itself in the economy. Something to be mindful of when investing in this environment.

Mark to market impacts more than just bank balance sheets

In many ways Silicon Valley and SVB’s customer base is the land of private of investments rather than the large tech companies that are publicly traded and well known by the public. Private start-ups, private equity and venture capital firms all banked with SVB. They have all prospered as more and more investors have embraced Dave Swensen’s Yale endowment model. They have also all been challenged by the current environment and account for the decline in deposits at SVB which precipitated the crisis.

You may believe that the concept of mark to market doesn’t apply to your own portfolio. It is true that it plays no role in public markets. Yet there has been a huge push into non-publicly traded assets. Especially from industry super funds.

According to ASFA’s Superannuation Statistics, an average MySuper fund holds over 20% of assets in unlisted property, infrastructure, and private equity. In total $232 billion is allocated to these asset classes. We have very little insight into what these assets are and at what valuation they are held. That is because in Australia full portfolio holdings disclosure is not required. There are a bunch of excuses the financial services industry uses to justify this lack of transparency. They are not worth going into because they are largely nonsense. Every other developed country requires full holdings disclosure and they are doing just fine.

My colleague Annika Bradley pointed out that the Aussie start-up Canva is the perfect example of our lack of transparency in Australia. Franklin Templeton wrote down the value of their private Canva investment by 58% in 2022. We know this because Franklin Templeton’s fund is required to do this under the law in the United States.

The mark to market on Canva makes senses. Afterall publicly traded small-cap technology shares had a terrible year in 2022. There is no plausible reason why a private company wouldn’t follow their lead. Are these assets being written down by super funds? We just don’t know. We do know that a changing interest rate environment does change valuation levels and a good deal of money was ploughed into these assets when interest rates were low. One would assume they are worth less now.

APRA launched an Unlisted Asset Valuation thematic review and highlighted “the need for considerable improvement in industry approaches to valuations and the need to conduct valuations proactively and regularly.” We will wait and see what happens.

Along with a lack of transparency there is also the question of liquidity. Selling private investments is not like selling a publicly traded share. These sales take time. If you want to do it quickly and are a motivated seller the prices can be impacted. Most industry super funds are comfortable with this lack of liquidity as they have relatively young members who are expected to continue to contribute for years before they need to withdrawal assets to pay for retirement.

This is all true. But a super fund is very different than a pension fund where members are locked into a single plan for life. We all have a choice about where our super is invested. If there is a lack of confidence about valuation levels there is a possibility – a slim possibility – of a “run on the bank”. If members transfer enough funds, private investments will need to be sold off. A sale of an asset that is sparsely transacted would give the market a view on what somebody is actually willing to pay for similar assets. Something the models used for valuation may not be accurately capturing. This could create a cascading effect where more assets are marked to market.

I certainly don’t think this is anything to panic about. I invest my super with Aussie Super which is one of biggest investors in private assets. But a situation involving a lack of transparency on assets held and their valuation, huge increases in the amount of funds allocated to private assets, concerned regulators and little liquidity is worth monitoring. Especially after interest rates have risen at an unprecedented speed.