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Asset valuation: Are there enough checks and balances?

Two surveys of hedge fund managers’ portfolio valuation policies have revealed a lack of standardization, highlighting a need for stricter valuation procedures, particularly when dealing with hard-to-value assets.

Correct valuations of portfolios are essential if investors are to get information about their exact returns and, on the basis of this, the compensation that their managers should receive. The surveys, by Deloitte and by Horizon Cash Management, point to the need for more work in the area of valuation.

According to the Deloitte survey of 60 managers worldwide, only 47% reported that they used a third party to provide independent pricing valuations. If managers receive compensation based on valuations, conducting valuations purely in house obviously raises questions about conflicts of interest. “There is a growing trend towards checking valuations using an independent administrator. However, for hard-to-value assets, often the manager is the best to do so,” says Barry Kolatch, author of Deloitte’s hedge fund study. “There is the potential for a conflict of interest, although we found most hedge fund managers do try to get this right.” Valuing hard-to-value assets such as credit default swaps, however, can be complicated, and managers should be using a variety of means to check their pricings. The survey revealed that 40% of respondents relied on broker quotes alone to do so. “There are many methods for pricing CDS and we think it is more legitimate to use more than one method,” says Kolatch.