Hard To Value Assets, Hedge Funds And Investment Fiduciaries

As I have pointed out on multiple occasions, valuation is an integral part of investment risk management for several reasons. First, fees paid to asset managers are frequently linked to performance and performance calculations depend on reported values. If values are artificially inflated, returns are likely to be inflated as well. Second, imprecise values can skew asset allocation decisions, lead to hedges being too big (or too small) and possibly cause an investor to breach trading limits that are part of an Investment Policy Statement. It’s no surprise then that valuation process questions about who does what, when and how continue to surface.

According to a May 9 Wall Street Journal article, the U.S. Securities and Exchange Commission (“SEC”) is investigating “the way hedge funds value their thinly traded holdings and how they respond when investors ask for their money back.” The SEC has been vocal about its concerns regarding asset valuations for awhile. In December 2012, Bruce Karpati, then Chief of the Asset Management Unit of the SEC Enforcement Division (and now in private industry), talked about a focus “on detecting fraudulent or weak valuation practices – including lax valuation committees and the use of side pockets to conceal losing illiquid positions – and the failure to follow a fund’s stated valuation procedures.” Click to read “Enforcement Priorities in the Alternative Space.” (As an aside, some hedge funds buy and sell actively traded securities for which there is a ready market and full price transparency.)

The U.S. Department of Labor (“DOL”) regularly broadcasts its concerns about “hard to value” assets, including financially engineered products that show up in certain defined benefit and defined contribution retirement plans. In September of 2008, I spoke before the ERISA Advisory Council, by invitation, to address valuation issues from the perspective of a trained appraiser and fiduciary best practices expert. Click to read “Testimonial Remarks Presented by Dr. Susan Mangiero.” I talked at length about valuation questions to ask of service providers and procedural prudence considerations for institutional investors.