The research carried out by the Alternative Investment Management Association (Aima) found that 28 per cent of respondents considered complex derivatives to be the biggest accounting headache, followed by distressed debt and mortgage-backed securities (12 per cent of respondents).
Of the hedge fund strategies identified as potentially giving rise to pricing and valuation issues, 35 per cent of respondents cited distressed debt, 18 per cent pointed the finger at fixed income arbitrage and 17 per cent mentioned convertible arbitrage.
The report titled “Asset Pricing and Fund Valuation Practices in the Hedge Fund Industry” placed special emphasis on harder-to-value instruments, which represented on average 14 per cent of the aggregate value of the funds managed by respondents. The research said that ascertaining the exact proportion of the hedge universe invested at any one time in such esoteric instruments is made difficult by the fact that the data is constantly changing.
Sixty-five per cent of all respondents were found to have a valuation error tolerance that their firm uses before re-calculating net asset valuation (NAV), while the highest percentage of that group, 29 per cent, displays a tolerance of 25-50 bps.
Seventy-three per cent of hedge fund managers were found to use an independent administrators to produce a NAV.
The report recommended that a hedge fund’s NAV should be produced by parties not involved in the investment process. In addition, it advised that a summary of workable pricing and valuation practices should be documented and the fund offering document should clearly describe potential limitations of pricing and valuation practices. The report found a perception that certain improvements to particular aspects of existing practices would be generally well received.
Institutional investors, managers and service providers (including prime brokers, administators and auditors) were canvassed in questionnaires and qualitative interviews representing 92 organisations. Administrator responses equated to over 50 per cent of the industry’s assets of $420bn.
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