Capco Partners Stuart Feffer and Christopher Kundro have released a white paper predicting that issues related to the valuation of hedge fund portfolios will likely become the next major black eye for the industry.<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />
Feffer and Kundro said: "Unless certain practices become more widespread, the industry faces a potential crisis of confidence with institutional and high net worth investors."
The Capco white paper is entitled "Valuation issues and operational risk in hedge funds". Valuation issues are already a factor in many headline-grabbing hedge fund blow-ups, and continue to be in the news as they increase in their frequency, severity and visibility. Recent evidence includes coverage of the SEC's staff report on "Implications of the growth of hedge funds," and the recent market-timing scandals in the mutual fund world.
A recent study by Capco on "Understanding and mitigating operational risk in hedge fund investments" found that valuation issues were a primary or contributing factor in approximately 35% of hedge fund failures.
The Capco white paper suggests that investors and fund managers insist that hedge funds follow three key principles in their valuation processes to ensure proper pricing:
The white paper also discusses the common reasons for valuation problems, which include the inherent difficulties in valuing certain types of securities, as well as pricing mistakes, procedural problems, infrastructure issues, misrepresentation and fraud.
copyright hedgeweek 2004