Alternative Investment Portfolio Valuation
Portfolio valuations for hedge funds, private equity funds, infrastructure funds, real estate investment trusts, property investment funds and other alternative investment funds; AIFM Directive, Hedge Fund Standards Board, Private Equity Provisions of the CFA Institute’s Global Investment Performance Standards (GIPS)
Valuation and valuation policies and procedures
Portfolio valuation, particularly as it concerns hard to value assets, is a critical issue for alternative investment fund managers (AIFMs). As a consequence, valuation is a key component of the EU’s AIFM directive and existing alternative investment fund (AIF) guidance, such as the Hedge Fund Standard Board’s (HFSB) Standards. This is because valuation:
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is the basis for subscriptions to and redemptions from AIFs by investors;
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measures the AIFs performance; and
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affects the compensation of the AIFM.
The AIFM Directive requires in all cases the AIFM to implement appropriate and consistent valuation procedures resulting in a proper and independent valuation of assets of the AIF. It requires assets to be valued at least once a year – for open-ended funds the valuation frequency should be appropriate to the issuance and redemption frequency.
“A hedge fund manager should do what it reasonably can to enable and encourage the fund governing body to prepare and adopt a document (a “Valuation Policy Document”) covering all material aspects of the valuation process and valuation procedures and controls in respect of the fund. The Valuation Policy Document (which it is acknowledged will contain information which is proprietary to the hedge fund manager) should be reviewed regularly by the hedge fund manager, in consultation with the fund governing body, and be made available to investors upon request on a confidential basis.” - Segregation of functions in valuation – Disclosure Standards and Guidance [6], The HFSB Standards
Effectively, the standards stipulate that the process for valuation of assets and calculation of net asset value should be functionally independent from:
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The portfolio management of the AIFM; and
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The remuneration policy of the AIFM.
Other measures should ensure that conflicts of interest are prevented and that undue influence on employees undertaking the valuation function is prevented. In many instances, confidence will be enhanced through the use of an external valuer.
“A hedge fund manager should do what it reasonably can to enable and encourage the fund governing body to put in place valuation arrangements aimed at addressing and mitigating conflicts of interest in relation to asset valuation” - Segregation of functions in valuation – Governance Standards and Guidance [5], The HFSB Standards
The AIFM may also need to have its valuation procedures and any in-house valuations verified by an external valuer.
Background to the AIFM Directive
The AIFM Directive will apply to all EU AIFM, and non-EU AIFM managing EU AIF, irrespective of whether the AIF is marketed in Europe or not
The AIFM Directive aims to provide “a harmonised and stringent regulatory and supervisory framework for the activities of all AIFM, EU or non-EU, within the European Union”
There is a lighter regime (but with opt-in provision) for:
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AIFM where the cumulative AIF under management fall below a threshold of €100 million; and
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AIFM that manage only unleveraged AIF that do not grant investors redemption rights during a period of five years where the cumulative AIF under management fall below a threshold of €500 million.
Portfolio Valuation: Service Options
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Range of Value
Opinion - a range of Fair Value for the subject company
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Data is obtained from the fund manager
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Direct contact with management of the subject company
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Generally includes due diligence meeting
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Valuation approaches used are based on the data available to, and provided by, the fund manager
Full Scope Valuation
Opinion - a Fair Value point estimate
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Scope is similar to the due diligence process for an acquisition
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Includes due diligence visit with the subject company’s senior management, and division/ product leaders
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Data is obtained directly from the subject company’s management
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All relevant valuation approaches considered
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Negative Assurance
Opinion - that the fund manager’s mark is “not unreasonable”
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Data obtained from the fund manager
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No direct contact with the management of the subject company
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Due diligence meetings are rare
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Valuation deemed reasonable based on the fund manager’s analysis
Positive Assurance
Opinion - that the fund manager’s mark is “reasonable”
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Data is obtained from the fund manager
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May include direct contact with management of the subject company
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May include due diligence meeting
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Valuation deemed reasonable based on the fund manager’s analysis
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Value added to Stakeholders
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Existing Investors
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Provides consistent, transparent information to monitor fund investments
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Increased focus on fund managers who demonstrate Fair Value best practices
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Allows investors to calculate their own performance
Prospective Investors
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Awareness and requirements for robust valuations are increasing
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Investors are often willing to bear valuation and monitoring expenses
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GAAP (including Fair Value) is a standard requirement in fund agreements
Deal Teams
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Encourages consistent analysis and documentation
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Efficiently provides Fair Value assessments to other stakeholders
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Helps to create meaningful internal position monitoring and valuation reporting support
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Fund Managers
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Provides additional, focused information to monitor portfolio’s regularly
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Supports review of valuations with deal teams and investors
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Ensures appropriate fund-level governance
Reporting Teams
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Provides independent Fair Value assessments on portfolio investments
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Demonstrates best practice valuation standards by the fund
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Assists reporting teams in creating internal valuations that are consistent, credible and fully compliant with GAAP
Auditors
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Makes interim and year-end auditing more efficient
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Provides independent review of valuation assessments
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Reduces the use of auditor valuation resources
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