IAFE Releases White Paper to help investors with fund valuations

Recent US hedge fund cases involving Clinton Group, Beacon Hill, Lancer Partners and Lipper & Co. have all centred on the disputed valuation of these funds’ illiquid holdings.

The White Paper is called "Valuation Concepts for Investment Companies and Financial Institutions and their Stakeholders" and, as its title suggests, seeks to address valuation concepts in some detail.

Valuation is a keystone of the asset and liability management business. The IAFE stated: "Properly valuing portfolios requires well-designed systems, procedures, policies and people. Stakeholders should satisfy themselves that the pricing procedures that investment company and financial institution managers use conform to the highest standards of correctness, fairness, transparency, and internal consistency."

To assist investors, the IAFE Investor Risk Committee has produced a list of concepts to promote a thoughtful discussion around the many issues related to valuation.

The White Paper is designed to help investors develop their own set of criteria, as part of ongoing discussions about valuation procedures with managers. The approach is pedagogical, namely addressing topics in the form of questions, to assist less experienced investors and managers looking for information about important valuation concepts.

Grouped into 12 broad categories, the topics are addressed in the form of questions that investors, financial advisers, auditors, bankers and regulators might want to ask fund managers. For example, some of the questions ask: "What are the potential conflicts of interest in marking assets and liabilities?," "Does the firm have a valuation committee?" and "Does the firm rely on pricing services?"

The White Paper makes no conclusions as to which methods are better than others. In fact, the IAFE stresses that that the wide variety of investment strategies, and the inherent variability in pricing any financial instrument, make it difficult – if not dangerous – to arrive at one-size-fits-all rules.

For this reason, it is critical to understand the policies and procedures which underlie valuations. "Valuation Concepts" strongly discourages investors from turning the document into a written questionnaire. The IAFE stated: "Frank discussion about valuations is far better than a written response to each question in the document."

The IRC hopes that "Valuation Concepts" will prove useful also to managers interested in performing self-assessments of their own valuation procedures, external auditors of hedge funds, management firms, directors and trustees of mutual funds, the US Securities and Exchange Commission, and the US Internal Revenue Service, among others.

Background Note: The IAFE is a professional society dedicated to fostering the profession of quantitative finance by providing platforms for the discussion of cutting-edge and pivotal issues in the field. Founded in 1992, the IAFE is composed of individual academics and practitioners from banks, broker dealers, hedge funds, pension funds, asset-and-liability management firms, technology firms, regulatory bodies, accounting, consulting and law firms, and universities across the globe. The IAFE Investor Risk Committee began its work on "Valuation Concepts" in September 2002. The IRC is composed of individuals from: mutual and hedge fund managers, institutional investors, prime brokers, insurance, consultants, custodians, software and technology vendors, and others groups. The IRC’s collective experience in pricing across multiple individual portfolios, asset classes, and geographic locations is both broad and substantial.

The White Paper "Valuation Concepts for Investment Companies and Financial Institutions and their Stakeholders" can be viewed on the IAFE’s web site, www.iafe.org

copyright hedgeweek 2003