The V word — valuation — keeps circling the hedge fund industry, rearing its head more and more often as everyone from investors to regulators asks whether managers are really offering accurate asset reports. One of the most notable incidents of late occurred in July, when the Boston office of the U.S. Department of Labor announced an investigation into how corporate pension plan fiduciaries value alternative investments like hedge funds. The suggestion is that commonly used valuation practices may be in violation of ERISA, and the agency wants pension plans to require third-party valuations of assets rather than rely on managers to voluntarily come clean. The proposal could put the force of law into recommendations announced this spring by the President’s Working Group on Financial Markets, and it has some support.
“For plan sponsors to get the numbers from the hedge fund is not doing due diligence,” says Susan Mangiero, president of Pension Governance, a research firm in Trumbull, Connecticut. “To remain prudent, you have to do your own homework.”
Others believe legislating such practices may be going too far. Timothy Selby, a New York–based partner and head of the hedge fund practice at law firm Alston + Bird favors self-valuation by hedge funds. “They, rather than regulators, understand the industry best,” he says. “I think the PWG approach is a terrific one and that it will ultimately carry the day.” (The PWG recommendations include guidelines that stress clear manager disclosures to potential investors and emphasize the due-diligence responsibilities of fiduciaries.)
The Managed Funds Association, the Washington-based group that lobbies for the hedge fund industry, concurs, saying in a letter to the Department of Labor that the DoL’s Boston office has “unreasonable and impractical expectations.” The MFA also asserts that the Boston proposal may do little more than rattle investors and “have an adverse effect on the ability of pension plans to invest in alternative investment vehicles, to the detriment of plans.”
Regardless of whether valuation practices are eventually legislated, Brian Tsai, chief operating officer for $1.3 billion New York–based hedge fund firm Equinox Partners, thinks they should be reliable — now and in the future. “Firms need to have operations to tackle pricing, fair value, consistency in protocol and trade settlement, as well as portfolios of illiquid assets,” he says.
Complicating the question of whether and when the government gets involved is the issue of which agency would do the enforcing. “People are questioning whether the Department of Labor can be effective,” says Karl D’Cunha, Chicago-based co-head of the hedge fund advisory services group at business-valuation firm Houlihan Smith & Co. He notes that valuation wasn’t such a hot issue with investors or regulators when hedge funds were logging better returns than most of them are now. “Robust valuation wasn’t on their checklist — now it is.”
