AIMA Sound Practices for Hedge Fund Valuations

AIMA’S GUIDETO SOUND PRACTICES FOR HEDGE FUND VALUATION

MARCH 2007

AIMA’S GUIDE TO SOUND PRACTICES FOR HEDGE FUND VALUATION (2007)

2

Contents

Introduction

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3Executive Summary

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5

AIMA’s 15 Recommendations for Hedge Fund Valuation

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9

Overview of Valuation Issues

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13

Valuation

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

14Hedge Funds

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14Scope of the Study

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17Responsibility for Valuation

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17Independence and Competence

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18Prudence and Fairness

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19Consistency and Flexibility

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20Accounting Standards and Valuation Policies

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21

Recommendations on Governance

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23

01 - Valuation Policy Document: Approval

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2402 - Valuation Policy Document: Contents

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2503 - Selection of Valuation Service Provider

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2604 - Escalation Procedures

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28

Recommendations on Transparency

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31

05 - Offering Document Disclosures

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3206 - Disclosure of Investment Manager Involvement

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3307 - NAV Reporting

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35

Recommendations on Procedures, Processes & Systems

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37

08 - Segregation of Duties

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3809 - Supporting Information

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3910 - Practical Implementation

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4011 - Consistency of Application

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41

Recommendations on Sources, Models & Methodology

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43

12 - Multiple Sources

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4413 - Broker Quotations

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4514 - Pricing Models

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4615 - Side Pockets

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48

Appendix 1: About AIMA

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53Appendix 2: AIMAAsset Pricing Committee & Guide Reviewers

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55Appendix 3: Hedge Fund Stakeholders

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57Appendix 4: Fair Value – Accounting Guidelines

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63Appendix 5: Valuation Policy Document Outline

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67The full Guide is available for purchase.Members

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£15Non-members

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£50Prices exclude postage and VAT, where appropriate.

AIMA’s Guide to Sound Practices for Hedge Fund Valuation is not to be taken or treated as a substitute for specific advice, whether legal advice or otherwise. Itdoes not seek to provide advice on any of the issues herein.© The Alternative Investment Management Association Ltd (AIMA) 2007All rights reserved. No part of this publication may be reproduced in any material form (including photocopying or storing it in any medium by electronic meansand whether or not transiently or incidentally to some other use of this publication) without written permission except in accordance with the provisions of theCopyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency. Application for permission for other use ofcopyright materials including permission to reproduce extracts in other published works shall be made to The Alternative Investment Management AssociationLimited. Full acknowledgement to authors, publisher and source must be given. Warning: The doing of an unauthorised act in relation to a copyright work mayresult in both a civil claim for damages and criminal prosecution.

AIMA’S GUIDE TO SOUND PRACTICES FOR HEDGE FUND VALUATION (2007)

3

Introduction

3

It has always been a goal of the hedge fundindustry to drive forward initiatives in orderto enhance sound practices.In 2005, AIMApublished its research on

AssetPricing and Fund Valuation Practices in theHedge Fund Industry.

1

This ground-breakingstudy was two years in the making andincluded a global survey of hedge fundmanagers, investors and fund administrators.The intention was to gain an understandingof perceptions and practices in this area:topics covered included the use ofindependent administrators, the range ofinstrument pricing sources, governance overfund valuation and the various roles of thoseinvolved in the pricing function. We issued20 practical Recommendations for soundvaluation practices within the industry.The study has been well received by theregulatory community. Indeed, the UKFinancial Services Authority (FSA) hasreferred to our work on valuation specificallyin its most detailed analysis of the industry.

2

The International Organisation of SecuritiesCommissions (IOSCO) is scheduled to release,for public consultation, a paper on valuationprinciples for complex and illiquid financialinstruments in the second quarter of 2007.AIMAbelieves that the enhancement of soundpractices in the area of valuation is an ongoingprocess, given the evolution of different typesof instruments and developments in valuationtechniques. In this publication you will findthe original 20 Recommendations have beenstreamlined into 15. Enhancements to theRecommendations have been made to reflectdevelopments in the industry and to removeany duplication where it may have existed.While a number of Recommendations havebeen combined or condensed they have notbeen diluted. The body of the documentprovides more detailed commentary on theRecommendations, together with practicalexamples of sound and unsound practice.AIMAis supported by over 1,100 membercompanies in 47 countries. The creation ofits range of guides to sound practices and itsmany other initiatives would not have beenpossible without the contribution ofvolunteers. For this publication it was alsoimportant for us to be able to draw on theexperience of a meaningful cross-section ofmanagers, investors, administrators andpricing specialists. We express our mostsincere gratitude and appreciation to theauthors of this study, each of whom is namedin Appendix 2. They expended considerabletime and effort to complete Phase II of thisimportant project on valuation practices.This study has been designed for use by fundmanagers, investors and all those servicingand providing professional advice to thehedge fund industry. We believe that you willfind the study practical and helpful and thatAIMA’s 15 Recommendations can be adoptedas sound practice across the industry.We welcome your input on any of the itemswithin; please contact info@aima.org.

Olwyn Alexander

Co-chair

Kieran Conroy

Co-chair

AIMAAsset Pricing Committee

1

- Published by AIMAin April 2005. The Executive Summary, containing our original Recommendations, can be found atwww.aima.org under Knowledge Centre/Research.

2

- See

Hedge Funds: Adiscussion of risk and regulatory engagement

(FSADiscussion Paper 05/04, June 2005), especiallysection 3.92ff.

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