Your fund probably holds a mix of liquid securities, private loans, real estate, and maybe some exotic derivatives. Come audit season, you need to defend every valuation with the right asset level classification, Level 1, 2, or 3, based on how observable your pricing inputs are.

Sounds straightforward until you’re explaining why that private credit facility isn’t Level 2 just because you found three vaguely similar deals on Bloomberg. Or why your LP stakes need Level 3 treatment even though the underlying portfolio has public comps.

Classification drives everything: your valuation methodology, your documentation requirements, your audit scrutiny. Get it wrong and you’re looking at restatements, delayed audits, and uncomfortable conversations with LPs about valuation adjustments. So, let’s clear up exactly what separates each asset level.

Asset Level 1: The Easy Ones With Price Tags

Level 1 assets are the straightforward part of your portfolio. We’re talking about NYSE-listed equities, Treasury bills, and major ETFs that trade constantly with transparent pricing. You pull the closing price from Bloomberg, put it in your NAV, and you’re done.

The key to asset Level 1 classification is an active market. Apple shares work because millions of trades happen daily, creating a reliable price that reflects what you’d actually receive if you sold today. That micro-cap stock with two trades per month? Different story. Light trading means the posted price might be stale or unrealistic.

Auditors love Level 1 assets because the market has already determined their fair value through actual transactions. You’re just reporting what thousands of buyers and sellers agreed on. When these quoted prices exist, IFRS and GAAP require you to use them exactly as published. It’s the cleanest valuation you’ll ever defend.

Asset Level 2: When You Need to Get Creative (But Not Too Creative)

Level 2 territory starts where direct market quotes end. Your corporate bonds that trade once a week, your interest rate swaps, those OTC derivatives — they all live here because you can’t just grab a closing price.

Instead, you build valuations using observable market data. Take that corporate bond without daily trades. You value it using similar bonds’ yields, the issuer’s credit spread, and Treasury curves. The inputs come from the market, but you’re connecting the dots yourself.

Asset Level 2 classification also requires documenting every input source. Auditors want to see precisely which yield curves and credit spreads you used. The math can get complex, but everything traces back to market data you can point to on a screen. 

Once you start making subjective adjustments or using proprietary assumptions, you’ve crossed into Level 3 territory.

Asset Level 3

Level 3 is where things get messy. These are your private equity stakes, your illiquid fund positions, your complex CLO tranches that nobody trades. Market data doesn’t exist, so you’re building valuations from scratch using internal models and your best assumptions about what a buyer might pay.

Essentially, asset Level 3 classification means you’re on your own. You project cash flows, pick discount rates, and estimate exit multiples based on whatever information you can find. Even if you hire an appraiser or use comparable transactions from two years ago, you’re still making educated guesses that auditors will scrutinize heavily.

The documentation burden here is real. Every assumption needs justification, every model input needs support, and you’ll need sensitivity analyses showing how changes affect valuation. Expect lengthy audit discussions and detailed footnotes explaining your methodology.

How We Can Help With Your Asset Level Classifications

You’ve got the classifications figured out, but defending them to auditors and LPs is another story. At Michael Coglianese CPA, P.C., we’ve spent over 30 years working with hedge funds, PE shops, and other alternative investment firms on exactly these valuation challenges. Our audit and advisory teams know what regulators scrutinize and what makes auditors dig deeper. Here’s how we turn your asset level documentation from a quarterly scramble into a systematic process:

• We Build Your Fair Value Policy From Scratch: We draft clear rules for when something moves from Level 1 to Level 2 to Level 3, who makes those calls, and what triggers reclassification. Your ops team gets actual procedures they can follow monthly instead of reinventing the wheel every quarter.
• We Lock Down Your Level 1 Documentation: We validate that your “active market” claims hold water and tie every quoted price to independent sources. No more explaining to auditors why that micro-cap stock you called Level 1 only traded three times last quarter.
• We Create Standardized Level 2 Model Packs: We build templates for your bonds and OTC derivatives that spell out which yield curves you used, where the credit spreads came from, and how you interpolated between data points. Everything auditors want to see is organized before they ask.
• We Write Level 3 Memos That Work: We produce valuation memos with calibration details, sensitivity tables, and clear documentation of every assumption — the kind of backup that makes audit fieldwork shorter and less painful.
• We Handle the Disclosure Package Right: We compile the entire ASC 820 footnote with fair value tables, transfer analyses, and quantitative details on your unobservable inputs. Your financial statements match your valuation documentation, and everything ties together cleanly.

Get Your Classifications Right Before Auditors Make You Wrong

Level 1, 2, and 3 classifications boil down to one question: How much market data backs up your valuation? Level 1 gives you actual traded prices, Level 2 lets you use observable market inputs to build a price, and Level 3 forces you to make your best guess when markets give you nothing. The hierarchy sounds simple enough until you’re sitting across from auditors who want to know why that thinly traded loan counts as Level 2 or why your model assumptions for that private equity stake make sense. Every fund manager learns the hard way that getting classifications wrong leads to restatements, audit delays, and awkward LP calls about NAV adjustments.

We’ve spent three decades helping alternative investment firms navigate these exact valuation challenges. Michael Coglianese CPA, P.C. brings specialized expertise in hedge fund, PE, and real estate fund audits, plus deep knowledge of IFRS 13 and ASC 820 requirements. We help you build defensible fair value policies, create flawless documentation for each asset level, and prepare disclosure packages that satisfy both auditors and regulators. Your valuations become systematic rather than scrambled, and your audit fieldwork gets shorter and cleaner.

Contact Michael Coglianese CPA, P.C. today to get your asset valuations and compliance in order.