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Many European hedge funds have Boards of
Directors ("the Board"). As pressures
build to achieve more consistency and ultimately
global standards in hedge fund valuation
processes and structures, here are four
areas which the Board needs to be addressing
today:
Documented pricing policy: There
is no excuse for not having a documented
pricing policy, no matter how simple the
portfolio may appear. It needs to be clear
and readily understood by administrators,
as well as the investment managers who implement
it and the Board who must approve it. It
should be as comprehensive as possible to
eliminate or minimise areas of subjectivity
and inconsistency. Finally the documented
pricing policy should be current
kept up to date for advances in best practices
and valuation methodologies. It should be
recognised as a working document and regularly
reviewed and updated.
Independence: A party independent
of the investment manager should value the
portfolio regularly. In Europe this tends
to be a third party administrator whereas
in the US, where valuation is often performed
in-house, it should be a separate operations
department, with a good price challenge
mechanism in place. The most effective way
for this to work in practice is through
valuation committees. In an ideal world
the independent partys pricing source
will also be independent of the investment
manager, for example using Bloomberg if
the manager uses Reuters, so that if a reconciliation
is performed and overrides are permitted,
differences can be challenged.
Segregation of duties: It is critical
that traders and investment managers do
not have ultimate power in dictating valuation.
There needs to be segregation of duties.
A proactive independent party should be
engaged who can produce a Net Asset Valuation
regularly, reliably and consistently. In
practice the best hedge funds permit overrides
by the investment manager only within documented
guidelines and limits which are then communicated
to the Board on a regular basis to allow
for adequate monitoring. Standardisation
of these practices would be a very positive
step forward.
Supervision and oversight: Ideally
the Board should have at least one member,
independent of the investment manager, who
is familiar with the funds strategy,
the instrument types and their relevant
valuation issues. This director then has
the ability to adequately supervise price
overrides, the regularity and quantum of
such overrides and question valuation issues
in detail as dictated by the risk level
involved. The communication to the Board
should be in line with recommended standards
such as a summary of stale prices,
price overrides, liquidity issues and non-exchange
traded investment valuations being reported
and approved. There should be an opportunity
for Boards to query problems or probe issues.
All this should be regularly presented,
with the overrides and pricing procedures
approved as needed.
The hedge fund industry must be seen to
react to instances of fraud and poor valuation
practices by being proactive, and the tone
should come from the top, with the Board
ensuring that they have implemented documented
pricing procedures, good supervisory and
oversight processes, independence in the
valuation process and a strong code of ethics.
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