Aima'S Guide To Sound Practices For Hedge Fund Valuation: MARCH 2007

AIMAS GUIDE
TO SOUND PRACTICES FOR

HEDGE FUND VALUATION
MARCH 2007
A I M A S G U I D E TO S O U N D P R A C T I C E S F O R H E D G E F U N D VA L U AT I O N ( 2 0 0 7 )
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
AIMAs 15 Recommendations for Hedge Fund Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Overview of Valuation Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Hedge Funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Scope of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Responsibility for Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Independence and Competence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Prudence and Fairness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Consistency and Flexibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Accounting Standards and Valuation Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Recommendations on Governance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
01 - Valuation Policy Document: Approval . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
02 - Valuation Policy Document: Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
03 - Selection of Valuation Service Provider . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
04 - Escalation Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Recommendations on Transparency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
05 - Offering Document Disclosures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
06 - Disclosure of Investment Manager Involvement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
07 - NAV Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Recommendations on Procedures, Processes & Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
08 - Segregation of Duties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
09 - Supporting Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
10 - Practical Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
11 - Consistency of Application . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
Recommendations on Sources, Models & Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
12 - Multiple Sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
13 - Broker Quotations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
14 - Pricing Models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
15 - Side Pockets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Appendix 1: About AIMA
......................................................................
53
Appendix 2: AIMA Asset Pricing Committee & Guide Reviewers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Appendix 3: Hedge Fund Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
Appendix 4: Fair Value Accounting Guidelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Appendix 5: Valuation Policy Document Outline
............................................
67
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AIMAs 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. It
does not seek to provide advice on any of the issues herein.
The Alternative Investment Management Association Ltd (AIMA) 2007
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Introduction
It has always been a goal of the hedge fund
any duplication where it may have existed.
industry to drive forward initiatives in order
While a number of Recommendations have
to enhance sound practices.
been combined or condensed they have not
In 2005, AIMA published its research on Asset

Pricing and Fund Valuation Practices in the
Hedge Fund Industry.1 This ground-breaking
study was two years in the making and
been diluted.
The body of the document
provides more detailed commentary on the

Recommendations, together with practical
examples of sound and unsound practice.
included a global survey of hedge fund
AIMA is supported by over 1,100 member
managers, investors and fund administrators.
companies in 47 countries. The creation of
The intention was to gain an understanding
its range of guides to sound practices and its
of perceptions and practices in this area:
many other initiatives would not have been
topics
possible
covered
included
the
use
of
without
the
contribution
of
independent administrators, the range of
volunteers. For this publication it was also
instrument pricing sources, governance over
important for us to be able to draw on the
fund valuation and the various roles of those
experience of a meaningful cross-section of
involved in the pricing function. We issued
managers, investors, administrators and
20 practical Recommendations for sound
pricing specialists.
valuation practices within the industry.
sincere gratitude and appreciation to the
The study has been well received by the

regulatory community. Indeed, the UK
Financial Services Authority (FSA) has
referred to our work on valuation specifically
We express our most
authors of this study, each of whom is named

in Appendix 2. They expended considerable
time and effort to complete Phase II of this
important project on valuation practices.
in its most detailed analysis of the industry.2
This study has been designed for use by fund
The International Organisation of Securities
managers, investors and all those servicing
Commissions (IOSCO) is scheduled to release,
and providing professional advice to the
for public consultation, a paper on valuation
hedge fund industry. We believe that you will
principles for complex and illiquid financial
find the study practical and helpful and that
instruments in the second quarter of 2007.
AIMAs 15 Recommendations can be adopted
AIMA believes that the enhancement of sound
as sound practice across the industry.
practices in the area of valuation is an ongoing
We welcome your input on any of the items
process, given the evolution of different types
within; please contact info@aima.org.
of instruments and developments in valuation

techniques. In this publication you will find
the original 20 Recommendations have been
streamlined into 15. Enhancements to the
Olwyn Alexander
Co-chair
Recommendations have been made to reflect
Kieran Conroy
Co-chair
developments in the industry and to remove
AIMA Asset Pricing Committee
1 - Published by AIMA in April 2005. The Executive Summary, containing our original Recommendations, can be found at
www.aima.org under Knowledge Centre/Research.
2 - See Hedge Funds: A discussion of risk and regulatory engagement (FSA Discussion Paper 05/04, June 2005), especially
section 3.92ff.
Executive
Summary
Executive Summary
Drawing on feedback after its initial survey
Service Provider.
The Valuation Service
of valuation issues in the industry, AIMA has
Provider will typically be the Funds
brought together a broad working party of
Administrator. The triangular relationship of
experts, representing all stakeholders in
Governing Body, Valuation Service Provider
the valuation process, to explore the issues
and Investment Manager will vary from
raised in more detail. The working party has
situation to situation, but its dynamics
sought to streamline AIMAs original 20
shape the management of the equilibrium
Recommendations in order to reflect more
between independence and competence
detailed representations from stakeholders
which is at the heart of the hedge fund
and to take full account of ongoing
valuation process.
developments in the industry, such as the

increasing use of side pockets.
AIMAs 15 Recommendations are reproduced

below. The working partys main conclusions
The hedge fund industry is global and ever-
may be summarised as follows:
evolving, embracing a wide range of

instrument types and market conventions.
Governance
A "one size fits all" approach to the
All hedge funds should have in place a
valuation of hedge funds would therefore
detailed
be unwise and unworkable. AIMAs revised
approved by the Governing Body after
15 Recommendations are not intended to
consultation with other stakeholders.
represent a comprehensive or prescriptive
Conflicts of interest in the valuation
set of rules, and may not be optimal or
process are usually best managed by the
appropriate for all industry participants.
appointment
Rather, they are intended as principles-
competent Valuation Service Provider.
based
sound
If the Investment Manager is responsible
practices in the areas of governance,
for valuation and/or governance, robust
transparency, procedures and methodology
controls over conflicts of interest should be
(there is inevitably some overlap across
established.
guidelines
for
valuation
Valuation
of
an
Policy
Document,
independent
and
these headings).
Transparency
In its 2005 survey of valuation issues, AIMA
Investors have the right to expect
highlighted the fact that the Governing
disclosure of any material involvement by
Body
the Investment Manager in the production
of
Fund
has
ultimate
legal
responsibility for the valuation of the
of a Funds formal NAV.
Funds portfolio. In practice, the Governing

Body will delegate the responsibility for the
Procedures, Processes and Systems
production of the Funds Net Asset Value
The parties controlling a Funds valuation
(NAV) to another party.
process should be segregated from the parties
Throughout this
study we refer to this party as the Valuation
involved in the Funds investment process.
Executive Summary
Procedures should be capable of practical
The use of broker quotations and pricing
implementation and consistent application
models for formal valuation purposes should
by the Valuation Service Provider.
be sufficiently tested and controlled.

Any decision to allow the side-pocketing of
Sources, Models and Methodology
illiquid/hard-to-value positions should be
Wherever possible multiple price sources
taken only after careful consideration by a
should be used to verify the valuation of
Funds Governing Body, who should then
each position in a Funds portfolio.
ensure that side-pocket policies are properly

communicated and consistently applied.
AIMAs 15
Recommendations
for Hedge Fund
Valuation
AIMAs 15 Recommendations
for Hedge Fund Valuation
Recommendations on Governance
Recommendations on Transparency
1. In advance of the Funds launch a
5. The Funds Offering Document should
summary
explicitly
valuation
of
practical
practices,
and
workable
procedures
and
name
responsibility
the
for
party
the
to
whom
calculation,
controls should be enshrined in a Valuation
determination and production of NAV has
Policy Document and approved by the
been delegated.
Funds Governing Body, after consultation

with relevant stakeholders. The Valuation
6. There should be adequate disclosure of
Policy Document should be reviewed on a
any material involvement by the Investment
regular basis by the Governing Body.
Manager in the pricing of underlying

portfolio positions.
2. The Valuation Policy Document should

explicitly clarify the role of each party in
7. NAV reports should be addressed directly
the valuation process, should identify price
to investors by the Administrator, where an
sources for each instrument type and should
Administrator is used, and any NAVs
include a practical escalation or resolution
produced by the Investment Manager should
procedure
be qualified as such.
for
the
management
of
exceptions.
Recommendations on Procedures,
3. The Governing Body of the Fund should
Processes and Systems
ensure adequate segregation of duties in the

NAV determination process, which may be
8. The procedures enshrined in the Funds
achieved by delegating the calculation,
Valuation Policy Document should be
determination and production of the NAV to
designed to ensure that the parties
a suitably independent, competent and
controlling the Funds valuation process are
experienced Valuation Service Provider. If
segregated from the parties involved in the
the Investment Manager is responsible for
Funds investment process.
determining the NAV, and/or acts as the

Funds Governing Body, robust controls over
9. The industry recognises that in certain
conflicts of interest should be established.
instances the Investment Manager has the

best insight with respect to the valuation of
10
4. Oversight of the entire valuation process
particular instruments. Wherever prices are
and, in particular, resolution of pricing
provided or sourced by the Investment
issues associated with hard-to-price illiquid
Manager, the Valuation Service Provider
positions and exotic instruments remains
should
the ultimate responsibility of the Funds
supporting information by the Investment
Governing Body.
Manager.
be
furnished
with
sufficient
AIMAs 15 Recommendations
for Hedge Fund Valuation
10. Procedures described in the Valuation
15. Any decision to allow the side-pocketing
Policy Document of the Fund must be
of illiquid/hard-to-value positions should be
capable of practical implementation by the
taken only after careful consideration by a
Valuation Service Provider.
Funds Governing Body.
If the Governing
Body approves such a decision it should

11. The Valuation Service Provider should
ensure that side-pocket policies are clearly
use reasonable endeavours to apply any
communicated to all investors. The criteria
pricing policy consistently. Deviations from
for side-pocketing individual positions
the policy should be approved by the
should be as consistent as possible.
Governing Body in advance of any NAV being

released.
Recommendations on Sources,
Models and Methodology
12. Wherever possible the valuation of each
position in the Funds portfolio should be
checked against a primary and secondary
price
source.
The
Valuation
Policy
Document should outline the hierarchy of

sources to be used for each security type
and the tolerance levels for variances
between the sources.
13. If the Governing Body approves the use
of broker quotations for the valuation of
certain instruments, these quotations should
wherever possible be multiple, sourced
consistently and accessed by the Valuation
Service Provider independently without
intervention by the Investment Manager.
14. Any decision to use a pricing model
should be approved by the Governing Body
and
should
appropriate
be
properly
testing.
If
an
justified
by
Investment
Managers pricing models are used they

should be independently tested and verified.
11
Overview of
Valuation Issues
13
Overview of Valuation Issues
Valuation
the total assets invested in hedge funds are

estimated at approximately $1.4 trillion. As
For any portfolio of investments, accurate,
the level of assets increases, continued
fair and timely valuation is a prerequisite
focus
for asset managers and investors alike.
stakeholders on a number of matters
is
being
maintained
by
all
including valuation, risk management,

From a managers point of view, proper
compliance and operational risk.3
valuation of a portfolio is essential in order

to make informed investment and risk
Much of the debate on these subjects is wellinformed and stimulating. There is, however,
management decisions.
a strain of sensationalist reporting on hedge

From the investors point of view, fair
funds which assumes that the practices of a
valuation is the foundation on which analysis
handful of unscrupulous operators are
of the portfolios performance and volatility
prevalent throughout the sector. The more
of returns is based. More fundamentally, an
lurid articles caricature hedge fund managers
investor would normally expect that the
as unprincipled gamblers acting entirely
amount of cash paid to take an equity
outside any regulatory framework and valuing
interest in the portfolio and the amount of
their portfolios as they please. Such reports
cash received on withdrawal of an equity
are as untrue as they are unhelpful. The vast
interest is based on a formal and fair
majority of hedge fund managers behave in a
valuation of the portfolios assets/liabilities.
responsible manner and have an obvious

vested interest in the ongoing stability of
The absence of procedures and controls in
financial
markets
the area of valuation can lead to mis-
treatment of investors.
statements of a portfolios value, which in
valuation,
turn may have a detrimental impact upon
demonstrated that opinions and techniques
the decision-making processes of managers
may vary but that most stakeholders
and
AIMAs
and
the
equitable
In the area of
previous
study
scenarios,
understand the issues that arise and seek to
persistent overstatement of the value of a
address them as diligently as those who
portfolios net assets may hide or facilitate
operate in other financial sectors.
misappropriation of those assets.
also be observed that proprietary desks of
investors.
In
certain
It may
large financial institutions and collective
Hedge funds
investment schemes sold to retail investors

have not been entirely immune from
The hedge fund industry continues to
instances of misvaluation.
Valuation of
experience considerable and steady growth,
financial assets is an area where inherent
both in terms of the number of individual
risks can never be eliminated, regardless of
funds in existence and the assets under
how simple the asset class or investment
management across the sector. Currently,
vehicle may appear.
3 - The source for the total assets figure is Hedge Fund Research (data to end of 2006). A list of hedge fund stakeholders is
provided in Appendix 3.
14
It is true that hedge funds have certain
valuation risk in hedge funds but other
characteristics which make the valuation of
features of the industry and recent trends
their portfolios potentially more complex
are also relevant:
than the valuation of more traditional

collective investment schemes:
1. A fundamental principle of hedge fund

philosophy is that Investment Managers
1. The typical remuneration structure of a
should be substantially co-invested alongside
hedge fund, whilst aligning the interests of
their investors. This kind of alignment, an
the Investment Manager with the investor in a
obvious stimulus for good risk management,
transparent way, means that the Investment
is not so prevalent in traditional sectors.
Manager is likely to receive the majority of its

fee income for performance, calculated on
2. As shown by the analysis in the table on
the basis of the Net Asset Value of the Fund.
page 16, the percentage of hard-to-value

assets in hedge funds is difficult to quantify
2. Because of their sophistication, hedge
exactly but it is likely to be under a quarter
fund managers are more likely than
of total assets.
traditional asset managers to make material

investments in complex, hard-to-value
3. In general, hedge funds are currently
instruments, including derivative products
marketed only to sophisticated investors,
and private or illiquid positions.
who would be expected to appreciate the

tensions in the valuation process which we
3. Some hedge fund managers apply high
discuss in the following sections. In
levels of leverage or portfolio concentration,
addition, the scrutiny which these investors
which can increase the materiality of
bring to bear on the valuation process helps
misvaluations should they occur.
improve practices.
4. Hedge funds normally undergo a formal
4. Developments in fund administration and
valuation process once a month, whereas
specialist pricing services are enhancing the
more traditional collective investment
quality of procedures. Some Valuation
schemes tend to be valued more frequently.
Service Providers provide daily indicative

valuations for a Funds portfolio, which tend
5. The valuation policies of hedge funds,
to make the formal month-end Net Asset
whilst often very similar, are enshrined in
Value exercise smoother. Pricing specialists
each individual Funds Offering Document
have improved their coverage of hard-to-
and constitution, and are not subject to a
value asset classes so that more hedge fund
standardised rules-based approach.
managers are using their services.
These characteristics should be taken into
5. There seems to be a discernible trend, in
account when considering the level of
areas such as governance and transparency,
15
of hedge fund managers embracing sound

principles,
which
they
find
do
not
compromise their investment flexibility in

the same way as a prescriptive rules-based
approach.4
Easy-to-Value and Hard-to-Value Strategies

In our 2005 study on Asset Pricing we attempted to give a broad-brush appraisal of the percentage of assets
managed in the hedge fund industry which are easy-to-value and hard-to-value.
As was pointed out in that study, such a distinction is somewhat arbitrary in nature given that public information on
the instrument types traded by managers in each strategy is limited. AIMA has sought to provide more granularity
by estimating the allocation to easy-to-value and hard-to-value instruments by strategies which straddle both types
of position. These estimates draw on the experience of the working party and are intended to be conservative.
For strategies still allocated entirely to one column or the other, some of the equity strategies may have immaterial
allocations to hard-to-value positions, but this is counterbalanced by the fact that many fixed income strategies
include quoted, highly liquid instruments in their portfolios.
It should be noted for the sake of consistency that, if the same categorisations were used as in the 2005 study, the
percentage of hedge fund assets in the hard-to-value column would have risen only marginally to 22% from 20%.
Strategy
Source for strategy asset

totals: Hedge Fund Research
(data to end of 2006).
Source for allocations to
each column: AIMA
Total
Convertible Arbitrage
Distressed Securities
Emerging Markets
Equity Hedge
Equity Market Neutral
Equity Non-hedge
Event-driven
FI: Arbitrage
FI: Convertible Bonds
FI: Diversified
FI: High Yield
FI: Mortgage-backed Securities
Macro
Market Timing
Merger Arbitrage
Regulation D
Relative Value Arbitrage
Sector
Short Selling
Easy-to-value
Hard-to-value
Assets ($m)
1,110,114 (77%)
22,614 (50%)
Assets ($m)
326,452 (23%)
22,614 (50%)
62,775
12,527 (20%)
50,106 (80%)
409,038
36,096
59,208
154,655 (80%)
132,548 (85%)
4,993
22,114
132,128 (70%)
72,477
4,137
38,664 (20%)
41,375
1,284
21,543
12,412
29,818
23,391 (15%)
3,424
56,625 (30%)
4 - For example, whereas our original 2005 survey found that only 38% of hedge funds had a documented valuation policy in
place, a recent study now puts the figure at 86%. See Asset Pricing, p.15 and Precautions that Pay Off (Deloitte Research,
2007), p.12.
16
Scope of the study
our main focus is not on any informal

valuation processes carried out between
The objective of this document is to further
formal valuations. The portfolios of many
expand on the practical Recommendations
hedge funds are valued on a frequent
covering the formal valuation of hedge
(typically daily) basis by the Investment
funds which were identified in the original
Manager, and/or some of the funds service
Asset Pricing and Fund Valuation Practices
providers. These valuations are produced
Illustrative
for a variety of reasons, such as ongoing
examples of sound and sub-optimal practice
profit-and-loss reporting, risk management,
are
in the Hedge Fund Industry.
Recom-
collateral management/margin calculation,
mendation. Again, the focus of the study is
also
provided
for
each
and additional transparency for investors.
the valuation of individual hedge funds
The valuations are sometimes struck to
rather than the valuation of funds of hedge
high standards, and are clearly important
funds.
for the purposes of management and

control.
While we may refer to these
As in the previous study, we make reference
informal valuations in passing we are
to the Net Asset Value (NAV) of a Fund, as
primarily concerned with the formal month-
this is the generally understood term for the
end process.5
valuation upon which investor subscriptions

and redemptions are based. However, we
Responsibility for valuation
again concentrate on issues relating to the

investment portfolio, rather than the
Each hedge funds Offering Document will
mechanics
and
set out the guiding principles for the
performance fee methodologies, as it is
valuation of the assets and liabilities of the
issues affecting the Gross Asset Value (GAV)
Fund.6 Usually included in these principles is
of a Fund that are likely to cause material
the
NAV misstatements. A full Valuation Policy
responsibility for the pricing of the Funds
Document would of course address issues,
assets
such as income/expense accruals and the
Governing Body of the Fund. The structure
calculation of performance fees, which are
of the governing entity will depend on that
outside the scope of this study.
of the Fund (see Appendix 3). For hedge
of
expense
accruals
disclosure
and
that
liabilities
the
rests
ultimate
with
the
funds organised in an offshore jurisdiction

While we touch on the subject of controls
the Governing Body is usually a Board of
over the existence of investments in a
Directors or Trustee; for those organised as
hedge fund portfolio (usually achieved by a
limited partnerships the Governing Body is
three-way
between
the General Partner (who will often be the
Administrator, Investment Manager and
Investment Manager or an affiliate of the
Prime Broker), we are primarily concerned
Investment Manager).
reconciliation
with specific valuation issues. Furthermore
5 - Hedge funds are required by their constitutions to carry out periodic formal valuations of their assets and liabilities.
By convention, hedge funds formally value their portfolios at each month-end. Even if a Funds official dealing days are less
frequent than monthly, the monthly valuation should be formal and consistent because the majority of hedge fund investors
use monthly NAVs for their analysis of performance and volatility. Of course, if a Fund has dealing days at points in time other
than month-end, the production of the underlying NAV should be subject to the same controls as month-end NAVs.
6 - In this Guide we will use the term Offering Document as the generic term for the document in which an offer of equity
interest is made by a Fund to investors. In the United States and Asia, such a document tends to be referred to as an Offering
Memorandum or Private Placement Memorandum; in Europe, a more common term is Fund Prospectus.
17
The practical responsibility for controlling
segregation of duties, are sufficient to
the determination of the Funds NAV is
manage its conflicts of interest.
usually
delegated
to
third
party.
Throughout this document we will describe
In certain circumstances, Governing Bodies
the party performing this role as the
may delegate oversight of the valuation
Valuation Service Provider. Typically, a
process to a sub-committee or separate
Funds Administrator will be the Valuation
committee, usually known as a Valuation
Service Provider as part of the services it is
Committee (or Pricing Committee). A
contracted to provide for the Fund.
Valuation Committee may be formed when

Governing Bodies conclude that they lack
For
any
portfolio
with
hard-to-value
specific valuation experience or when the
instruments, the Investment Manager will
valuation
have some input into the valuation process.
considered complex and requires regular
of
In certain circumstances, an affiliate or
review
division of the Investment Manager itself
appointment of a Valuation Committee is
acts as Valuation Service Provider (an
also common if the Fund is a partnership
arrangement sometimes referred to as
vehicle as it is one way of mitigating the
self-administration).
clear conflict of interest which exists when
by
the
an
Funds
portfolio
oversight
body.
is
The
the Investment Manager is also the General

The triangular relationship of the Governing
Partner (and therefore the Governing Body)
Body,
of the Fund.
Valuation
Service
Provider
and
Investment Manager will vary from situation

to situation, but it is fundamental to the
Independence and competence
dynamics of hedge fund valuation. If the

Valuation Service Provider is well-resourced
The main tension in the valuation of the
and fully independent of the Investment
complex
Manager, the Governing Body may serve in a
sometimes
high-level oversight role only. Where the
independence and competence. It is clearly
Investment
self-
preferable that the responsibility for the
administration, investors may look to the
valuation of a portfolio, position by
Governing Body to act in a stronger
position, is taken by a Valuation Service
Manager
practices
assets
trade
which
is
hedge
that
funds
between
If both Valuation Service
Provider who is not only independent of the
Provider and Governing Body are peripheral
Investment Manager but also has no other
influences (or if the Investment Manager
interests that materially conflict with its
acts in their positions), the onus falls
duties to the Fund.
oversight role.
squarely on the Investment Manager to

compensating
For those hedge funds investing in hard-to-
controls, such as reviews by independent
value instruments, however, it is unrealistic
parties, greater transparency and robust
to expect that the Investment Manager will
convince
investors
that
7 - This is one of several reasons why hedge fund Governing Bodies should have sufficient stature. AIMAs Offshore Alternative
Fund Directors Guide (June 2005) provides guidance on forming a suitably qualified and competent Board of Directors. The
Guide is available to AIMA members and institutional investors at no charge, and available for purchase by non-members at
aima.org.
18
have no input into valuation. A third party
placed to value the portfolio. In these cases
Valuation Service Provider may not have a
good
detailed working knowledge of pricing
meaningful controls over potential conflicts of
methodology for complex derivatives, or
interest are all the more crucial. It is certainly
direct access to price sources for thinly
not sound practice for a Governing Body to
traded securities. Several established hedge
approve self-administration without a clear
fund
own
Valuation Policy Document being in place
administrative infrastructure at a time when
which outlines robust segregation of the
there were few Valuation Service Providers
Investment Managers front and back offices.8
managers
built
up
their
governance,
transparency
and
with the necessary experience and resources

to provide formal valuation services. Some
AIMAs Recommendations also recognise
of these Investment Managers argue that the
that, even when a third party Valuation
industry has still not evolved to the point
Service Provider is delegated responsibility
where there is a sufficient supply of
for the overall NAV production process,
independent Valuation Service Providers
material
who can determine the NAV of a complex
Manager may still be required. Again, in
portfolio in a fully competent manner.
these situations, the role of governance,
Managers who favour self-administration
transparency and robust written procedures
also point to the fact that their investors
becomes all the more important and our
demand the production of month-end NAVs
Recommendations are designed to provide
to deadlines which an independent provider
guidance in these areas.
might not be able to meet.
possible, the input of the Investment
input
from
the
Investment
Wherever
Manager should be checked and reviewed

AIMA believes that the delegation of NAV
by the Valuation Service Provider and/or
production to a suitably experienced third
the Governing Body.
Sometimes the
party Valuation Service Provider is usually the
valuation of certain instrument types, or
optimal solution to the tension between
the review of the Investment Managers
independence and competence inherent in
pricing of the instrument type, is delegated
the valuation process. This is not to say that
to a third party specialist or to an
the appointment of an independent provider
independent accountant.
should be viewed as a panacea for all the risks

in the valuation process, nor that other
Prudence and fairness
stakeholders in the process should abdicate

their responsibilities. Furthermore, as our
Prudence is not only a fundamental
original Recommendations recognise, there
accounting concept but a natural attribute
are certain circumstances where a hedge fund
of responsible Investment Managers. If
portfolio is so esoteric or complex that a
there is an element of contingency to the
Valuation Service Provider related or internal
value of an investment because of its
to the Investment Manager may be best
illiquidity or the subjectivity of pricing
8 - The very terms front office and back office, used colloquially throughout the asset management industry, implicitly
recognise the segregation of duties which should exist between those involved in investment decisions/trading and those
responsible for reconciliations/accounting. We will sometimes use these shorthand terms when discussing the internal
procedures of an Investment Manager.
19
assumptions,
many
managers
are
Consistency and flexibility
understandably reluctant to mark up a

position until there is clear evidence of a
Stakeholders are entitled to expect that
substantive and sustainable change in
valuation policies are applied consistently so
circumstances.
that they can perform analysis in the

knowledge that the information goalposts
But hedge funds do not have the luxury of
are not being moved unreasonably. A lack of
automatically
conservative
consistency in the application of policies
They are usually
can lead to inaccurate and potentially
established as open-ended vehicles, and
misleading information being distributed
investors subscribe or redeem at each
and being relied upon by investors and
applying
approach to valuation.
dealing point on the basis of the same NAV.
other third parties. One of the aims of a
The value assigned to any particular
good Valuation Policy Document is to
position will have a direct impact on the
provide
number of shares that a subscriber receives
valuation policies and price sources.
framework
for
consistent
or the proceeds which will be paid to an

However, because of their broad mandates
investor who is exiting the Fund.
and innovative investment styles, hedge

In this regard, the practice of side-
funds may utilise newlycreated instrument
pocketing private, illiquid or hard-to-price
types
investments has become more prevalent
technical developments or changes in
and
hold
positions
subject
Flexibility,
to
since AIMAs original survey was released.
circumstances.
Side-pocket arrangements segregate such
attractive from an investment point of
usually
positions from the main pool of assets in a
view, does present challenges from a
Fund until such time as they are realised or
valuation perspective. When an Investment
are no longer difficult to price.
This
Manager contemplates investing in an
approach has its advocates in terms of
instrument type which has not been
prudence
investors,
included in a Funds portfolio previously or
especially given the typical j-curved
argues that the most influential market-
nature of returns on special situations.
makers for a thinly traded security have
However, multiple side pockets can be
changed, it should engage with the various
difficult to handle from an administration
stakeholders to ensure consensus on the
perspective, difficult for certain investors
fairest valuation of the position.
and
fairness
to
to accommodate and may even encourage
20
the dumping of impaired assets unless
Hedge funds are among the main consumers
properly controlled.
of products developed by investment banks,
The decision to
approve provisions for side-pocketing is not
including
complex,
one which the Governing Body should take
derivative contracts. In these circumstances
lightly.
valuation
by
the
specially
tailored
counterparty
is
sometimes the only means by which the
will be instances where the valuation of the
Investment Managers own valuation of the
Funds assets for the purposes of the NAV
contract can be initially verified. In due
calculation will not necessarily comply with
course, the derivative contract may become
the requirements of IFRS or US GAAP. For
a more common way of expressing an
example, IFRS mandates the use of bid
investment idea so that the Valuation
quotations for long positions and ask
Service Provider develops its own pricing
quotations for shorts, whereas many hedge
models or can find another third party
funds use either the last traded price or, in
specialist with the requisite expertise to
some circumstances, the middle of the
provide reliable model-based valuations.
spread. Additionally, US GAAP precludes the
This would be a clear-cut instance where a
use of blockage discounts where an
price source consistently used in the past
exchange-traded
should be superseded by a model giving a
regardless of the liquidity of the position.
more independent estimate of fair value.
The guidelines contained in this document,
The industry has demonstrated that it can
with accompanying examples, are intended
come to terms with the valuation of new
to represent current sound practice and
asset classes in this way. Few might have
therefore will be revisited and, if necessary,
predicted ten years ago that credit
revised to reflect changes in accounting
derivatives would become as mainstream as
standards or international regulation.
price
is
available,
they are today.
Accounting standards and valuation

policies
The
increasing
emphasis
placed
by
international accounting authorities on fair

value is discussed in Appendix 4.
AIMAs
Guide seeks to enhance sound practice

principles for the fair valuation of hedge
fund portfolios.
That being said, it is
important to re-emphasise the fact that this

document covers the valuation of assets for
NAV purposes.
implications
The requirements and

of
Financial
Reporting
Standards and, in particular, International

Financial Reporting Standards (IFRS) and US
Generally Accepted Accounting Principles
(US GAAP), have been considered in the
preparation of this Guide. However, there
21
Recommendations
on Governance
23
Valuation Policy Document : 1 - In advance of the Funds launch a
The Funds Governing Body should therefore
Approval summary of practical and workable
ensure that a written Valuation Policy
valuation practices, procedures and
Document is in place for the Fund. Ideally,
controls should be enshrined in a
the Document should be approved before
Valuation
and
the Funds launch after consultation with all
approved by the Funds Governing
relevant stakeholders. For a Fund with
Body, after consultation with relevant
hard-to-value securities, it is sensible for
Policy
Document
stakeholders. The Valuation Policy
the Funds Auditor to be involved in the
Document should be reviewed on a
consultation process, given that it will be
regular basis by the Governing Body.
performing work on valuation policies and

procedures in its year-end audits.
Regardless of how simple a Funds valuation

practices may appear, proper documentation
The regularity of review of the Valuation Policy
of the valuation process removes scope for
Document by the Governing Body will depend
dispute or uncertainty in the future and
upon the Funds complexity. Sound practice
provides a clear framework for governance in
would be to review the Document at least
the area.
annually and in any case when the Funds

activities involve new types of instrument.
By convention, the Offering Document which
Developments in accounting standards or
a Fund issues to its prospective investors
valuation practices should also be reflected in
before and after its launch contains a section
the Document on a timely basis.
on valuation. These disclosures are important
24
and are discussed under Recommendation 5.
For a Fund likely to have an allocation to
However, they do not usually address the
quasi-private positions, the Governing Body
detail of the practices and procedures
arranges dialogue between the Investment
applied in the production of the Funds
Manager and the Auditor to discuss the
formal month-end NAV. Inclusion of such
information and documentation the latter
detail would probably require the Offering
will require in its year-end audit fieldwork.
Document to be frequently revised, costing
For debt positions secured on property
the Funds stakeholders time and its investors
portfolios, the two parties agree on using
money. While it is therefore reasonable for a
annual
reports
from
an
independent
Funds Offering Document to provide a high-
property valuation specialist. The Valuation
level overview of valuation policies, this
Policy Document then states that the same
should be on the understanding that a more
specialist will be consulted on a quarterly
detailed summary of valuation procedures is
basis to ensure that the carrying value used
in existence and available for review.
for NAV purposes remains reasonable.
A Governing Body is persuaded that there

is no need for a Valuation Policy Document at
An outline of the approval process for the

use of pricing models.
all because the securities in the portfolio
An outline of the process for formulating
are normally 100% exchange-traded and easy
policies when the Fund starts to trade a
to price. This leads to a variety of practical
new investment type.
issues going forward. For example, there is
The accepted valuation processes, price
an ongoing issue because of a suspension of
sources and cut-off times for each type of
dealing in a particular security. Stakeholders
instrument expected to be traded by the
in the valuation process have no guidelines
Fund.
to follow and the Investment Manager
The accepted tolerance levels for any
persuades the Valuation Service Provider to
differences between price sources, both
process an arbitrary write-down of the

position in a month-end NAV calculation.
at position and portfolio level.

A definition agreed by all stakeholders of
what constitutes a stale price.
Valuation Policy Document: 2 - The Valuation Policy Document
For each type of hard-to-value instrument,
Contents should explicitly clarify the role of each
a methodology or procedure for arriving at
party in the valuation process, should
a consistent valuation to be included in
identify
price
sources
for
each
instrument type and should include a

practical
escalation
or
the NAV, outlined as clearly as possible.

A clearly defined escalation or resolution
resolution
process for situations in which tolerance
procedure for the management of
levels are breached, or where the degree
exceptions.
of subjectivity in pricing is such that the

Governing Body should periodically review
The Valuation Policy Document should be
in detail.
worded as clearly as possible and should act as

a practical guide for all stakeholders involved
An example outline of a Valuation Policy
in the formal NAV process. The Valuation Policy
Document is given in Appendix 5.
Document may also include guidelines for the

delivery of information or completion of a
A Fund has a policy on hard-to-value
process, although this is more related to the
convertible bonds where quotes from third-
service levels agreed between the parties.
party market-makers are sourced.
Its
Valuation Policy Document clarifies the

For the accuracy of the NAV process
number of quotations to be procured, the
specifically, it would be sound practice for a
method by which the Valuation Service
Valuation Policy Document to include guidance
Provider receives the quotations, and the
in the following areas, where applicable:
way the average price is to be calculated.

If there is a deviation from the written
The responsibilities of the parties involved.
policy, the valuation automatically becomes
The forums for, and frequency of, oversight
a reserved matter for the Governing Body.
of the valuation policies.
25
A Valuation Policy Document contains
should conduct sufficient due diligence on
clear detail on the price sources to be used
any
for each security type. However, there is no
committing the Fund to any relationship.9
guidance as to acceptable tolerance levels
In practice, there may be a beauty
if the price sources differ. This means that
parade during which the qualifications,
the
competence
Valuation
Service
Provider
takes
prospective
and
candidate
suitability
before
of
the
unilateral decisions as to whether or not to
providers are assessed. The Governing
escalate a difference between the price
Body may expect each candidate to
sources to the Governing Body.
supply:
Selection of Valuation 3 - The Governing Body of the Fund
1. Evidence of the robustness of its control
Service Provider should ensure adequate segregation
environment (this may take the form of an
of duties in the NAV determination
independent accountants SAS 70 or AAF01 /
process, which may be achieved by
06 report).10
delegating the calculation, deter-
2. Access to the senior personnel of the
mination and production of the NAV
Valuation Service Provider who will be
to a suitably independent, competent
responsible for managing the valuation
and experienced Valuation Service
process.
Provider. If the Investment Manager is
3. Evidence of experience in valuing the
responsible for determining the NAV,
instrument types which the Fund trades
and/or acts as the Funds Governing
(this may include references from other
Body, robust controls over conflicts of
hedge
interest should be established.
instrument types).
funds
4. Evidence
which
of
trade
sufficient
the
same
systems,
However difficult it may be to strike a balance
infrastructure and business continuity to
between independence and competence in
support the valuation process.
the area of valuation, a fundamental principle
5. Evidence that any internal conflicts of
of governance is that the NAV of a Fund should
interest are sufficiently managed (for
be produced independently of the Investment
example, a Valuation Service Provider with
Manager or that there should be effective
a prime brokerage arm should ensure that
controls over NAV production in the cases
information firewalls exist between the two
where the Investment Manager is responsible
divisions of the organisation).
for valuation.
During the due diligence process, members
Independent Valuation Service Providers
of the Governing Body will probably rely on
If the Governing Body of a Fund chooses to
advice and guidance from the Investment
delegate the production of the month-end
Manager but they will retain ultimate
NAV to a Valuation Service Provider it
discretion over the decision.
9 - See AIMAs Illustrative Questionnaire for Due Diligence of Hedge Fund Administrators (available to AIMA members and
institutional investors only).
10 - SAS 70 / AAF01/06 reports are produced by Auditors, in accordance with the relevant auditing standards, in order to
report on a service organisations controls environment. Such reports allow an organisation that provides third party services
to disclose their control activities and processes to their clients and their clients Auditors in a uniform reporting format.
26
It is sometimes argued that Valuation
may also ask the Provider to report to it in
Service Providers have a conflict of interest
person, especially if questions have been
because they usually receive remuneration
raised by the Investment Manager or Auditor.
in the form of a percentage of a Funds
It is also the ultimate responsibility of the
assets under management. This is true to
Governing Body to ensure that the Service
the extent that a growth in assets through
Level Agreement between the Fund and the
performance will feed through to their fee
Valuation Service Provider is kept up to date.
income, but it is important to stress that

the vast majority of Valuation Service
Self-administration by the Investment Manager
Providers follow sound practice by not
As noted in the Overview, for some Funds
receiving any remuneration directly linked
with hard-to-value securities in their
to performance. However, the Governing
portfolios, it may be concluded that the
Body should be alert to other threats to a
Investment Manager is best placed to
Valuation Service Providers independence.
provide the most accurate and timely
For example, a Valuation Service Provider
valuation of the portfolio. The Valuation
may be reliant on funds managed by one
Service Provider in these instances will
Investment Manager for the majority of its
either be an entity affiliated with the
income. This is a factor to be considered
Investment Manager or the back office of
along with any other conflicts of interest
the Manager itself.
caused by the nature of the Investment

Managers relationship with the Valuation
Where
these
arrangements
exist
the
Service Provider. If the Investment Manager
Governing Body should periodically satisfy
is a shareholder in a Valuation Service
itself that it continues to be in the Funds
Provider, or if the two organisations share
best interests for valuations to be produced
personnel,
the
by the Investment Manager. The Governing
Valuation Service Provider will clearly be
Body should also ensure that written
compromised.
procedures, segregation of duties and proper
the
independence
of
oversight are all in place. It should insist upon

Once the Valuation Service Provider has been
a Valuation Policy Document which specifies
selected, the precise details of its terms of
the methods and sources the Investment
engagement will be agreed, and are often
Manager uses, and which if possible names
enshrined in a Service Level Agreement.
the personnel at the Investment Manager who
Another benefit of producing a Valuation
will be responsible for valuation.
Policy Document is that this can be included
Governing Body may wish to have these staff
as part of the Service Level Agreement.
report directly to them on a periodic basis.
After the Fund is launched, the Governing
In some partnership structures where the
Body should periodically refresh its due
Investment Manager is the General Partner
diligence on the Valuation Service Provider. It
(and
therefore
the
Governing
The
Body),
27
A Governing Body, along with the
measures should be taken to address
potential conflicts of interest in the sphere
Investment Manager, visits a shortlist of
of governance. Some Investment Managers
independent Valuation Service Providers.
who are General Partners establish a
After due consideration, the Governing
Valuation Committee which acts as a de
Body appoints one of the candidates on the
facto Governing Body on matters relating to
basis of criteria such as the competence of
valuation. It is clearly preferable that this
its staff and its experience of valuing the
Committee
instruments which the Fund will trade.
should
include
as
many
members as possible who are independent

of the Investment Manager, although it is
A General Partner establishes an internal
recognised that it may be difficult to source
Valuation Committee where the lead portfolio
suitably competent members who are
manager has an arbitrary power of veto over
available at each month-end. At the very
the valuation of any instrument in the
least, a majority of the Committee should
portfolio without reference to parameters
be comprised of non-executives and/or
laid down by a Valuation Policy Document.
staff of the General Partner who do not
Escalation Procedures report to those involved in investment
4 - Oversight of the entire valuation
decisions. It is sound practice for staff from
process and, in particular, resolution
compliance and risk management functions
of pricing issues associated with
to be represented on the Committee. It is
hard-to-price illiquid positions and
also preferable that staff of the General
exotic
instruments
remains
the
Partner who sit on the Committee are not
ultimate responsibility of the Funds
remunerated directly on the basis of Fund
Governing Body.
performance.
To fulfil its responsibilities in this area the
A Funds Auditor may be engaged to perform
Governing Body should ensure that the
attestation work each month or quarter and
Valuation Policy Document of the Fund
to produce a report to provide some level of
allows it to review any positions where the
extra check for the Governing Body and
Investment Manager has material input into
investors upon valuations performed by the
the valuation of a position or where the
Investment Manager. These exercises are a
Investment Manager wishes to override the
useful tool of governance when self-
price provided by the Valuation Service
administration takes place, but they should
Provider.
not be relied upon in isolation.

In practice, escalation to Governing Body
28
Controls to manage potential conflicts of
level will tend to arise in two cases. Firstly,
interest and to ensure segregation of duties
there will be positions where it is accepted
are discussed further under Recommen-
that
dations 8 and 9.
effectively be the primary source of the
the
Investment
Manager
will
valuation (for example, a position in the
A Fund establishes in its Valuation Policy
convertible debt of a private company,
Document a clear protocol for the handling
where the Investment Manager may have
of overrides requested by the Investment
better insight into expected future cash-
Manager. This includes guidance as to the
flows than any other stakeholder in the
kind of evidence considered substantive by
valuation process). Secondly, and probably
the Valuation Committee, as well as a
more rarely, there may be instances where
reminder that the Committee is quorate
the Investment Manager and Valuation
only when a majority of members present
Service
are
Provider
have
genuine
disagreement about which price source or
independent
of
the
Investment
Manager.
model inputs should be used.

For a Fund where the back office acts as
In the first case, where documented
de facto Valuation Service Provider, a
procedures
the
number of its prices are overridden by the
Governing Body may chose to delegate
front-office team. The back office re-runs
monthly review of the valuation of the
the NAV report without any formal review
specific
Valuation
by the Governing Body or Valuation
Committee or to a suitably qualified
Committee. No documentation supporting
member of the Governing Body who is
the rationale for the front offices overrides
independent of the Investment Manager and
is maintained.
will
be
instruments
important,
to
the Valuation Service Provider. In addition,

the Governing Body may perform a periodic
review to ensure that the Investment
Managers involvement is required and that
the assumptions behind its input are
reasonable.
In the second case there should be a clearly
defined
escalation
procedure
in
the
Valuation Policy Document. The Governing

Body should receive representations from
the various parties involved in order to
reach a decision on the fairest price to be
used. In these circumstances, the burden
of proof for an override should lie with the
Investment Manager not the Valuation
Service Provider.
The reasons for the final
decision of the Governing Body should be

documented.
29
Recommendations
on Transparency
31
Recommendations
on Transparency
Offering Document 5 - The Funds Offering Document
for the identity of the Valuation Service
Disclosures should explicitly name the party to
Provider (whether independent of the
whom
responsibility
calculation,
for
the
Investment Manager or not) to be made
determination
and
completely unambiguous.
production of NAV has been delegated.

Other disclosures in an Offering Document
As noted under Recommendation 1, the
to help investors better understand the
Offering Document of the Fund contains
valuation process might include:
formal disclosures on which basis investors

subscribe to the Fund. It is normal practice
1. Clear disclosure of who has oversight
for the Offering Document to include a
responsibility for the valuation of the
section on Valuation or Net Asset Value.
Funds assets and liabilities (this would
By convention, disclosures made under this
include explanation of the role of the
heading
Valuation Committee if there is one).
will
include
details
of
the
frequency of the production of the NAV,
2. If the Investment Manager is likely to
headline valuation policies to be applied to
have material involvement in the valuation
each major category of assets/liabilities
of the portfolio, disclosure of that fact (see
and disclosures about risks inherent in the
also Recommendation 6 below).
valuation process.
3. Some guidance as to how fair value will

be ascertained in practice, if the Fund has
It is understandable that some of these
non-exchange-traded positions.
disclosures in the Offering Document are
4. Detailed disclosure of policies relating to
generic in nature, whereas the detailed
side pockets, should they be allowed for by
policies and procedures would be found in a
the Offering Document.
Valuation Policy Document. For example,

a
A Fund makes explicit disclosure in its
statement that the Funds valuation policies
Offering Document that the Investment
may be altered or overridden at the
Manager is delegated responsibility for
discretion of the Governing Body or
determining
Investment Manager without such discretion
Administrator acts merely as a Registrar.
Offering
Documents
often
include
the
NAV
and
that
the
being precisely defined.

A Fund where a division of the Investment
32
However, whatever the level of detail in the
Manager acts as Valuation Service Provider
Valuation Policy Document and the Funds
makes
policy relating to its disclosure, investors
determination of NAV in its Offering
no
disclosure
about
the
may
receive
Document, other than the potentially
meaningful information in the Offering
misleading statement that the NAV is
Document over and above boilerplate
disseminated at each month-end by the
language. In particular, it is sound practice
Administrator.
reasonably
expect
to
Disclosure of Investment 6
There
adequate
The process transparency granted by such
Manager Involvement disclosure of any material involvement
disclosure is not the same thing as portfolio
by the Investment Manager in the
transparency, about which the Investment
pricing
Manager may have genuine concerns. But if,
of
should
be
underlying
portfolio
positions.
for whatever reason, the Investment Manager

and / or Valuation Service Provider do not
When an independent Valuation Service
wish the Valuation Policy Document to be
Provider is delegated overall responsibility
available
for the determination of a Funds NAV,
bandwidth of NAV where the Investment
investors still have the right to expect
Manager might be involved should still be
disclosure of any material involvement by
disclosed.
to
investors,
the
expected
the Investment Manager in the process.

The definition of materiality in this context
It is also sound practice for the Funds
should be strict.
Disclosures do not have
audited financial statements to contain a
to take the form of a prescriptive health
note outlining the percentages of NAV as at
warning about the level of valuation risk
the balance sheet date which are valued by
in the Fund, but sufficient information
the Investment Manager, disclosing the
should be disclosed to investors for them to
methods used and the nature of the
be able to draw their own conclusions and
Managers involvement.11
make appropriate decisions.

A Governing Body, in consultation with the
for
Investment Manager, authorises disclosure of
disclosure to be made is the release, on a
the Funds Valuation Policy Document to
confidential basis, of the Funds Valuation
investors and potential investors.
The
most
straightforward
way
Policy Document. If potential investors are

provided with the Document during their
An Investment Manager has material
due diligence process, they may then
involvement in the pricing of hard-to-value
follow up with questions to the Investment
investments in a Funds portfolio, typically
Manager and/or Valuation Service Provider
representing 10-15% of the Funds net
about the typical percentages of NAV
assets. This fact is not recorded in any
represented by each main category of
documentation received by investors and
instrument.
not
Existing
investors
might
reasonably expect such disclosure to be
voluntarily
disclosed
during
any
investors due diligence process.
repeated annually at their request, or

whenever the percentage of NAV in which
the Investment Manager has involvement
changes materially.
11 - For year-ends from late 2007 onwards, financial statements prepared under US GAAP must include a disclosure note
outlining the percentage of net assets in each of the three levels defined by FAS 157 (see Appendix 4 for further details).
33
In 2000, the Investor Risk Committee of the International Association of Financial Engineers
proposed that there were four dimensions in which information provided by hedge fund
managers should be evaluated.12 The AIMA working party has used these headings - content,
granularity, frequency and delay to organise some typical questions about transparency
pertaining to the hedge fund valuation process specifically:
IRC framework
framework applied
applied to
to the
the valuation
valuation process
process
IRC
Content
What is the quality and sufficiency of coverage in the information

disclosed about the valuation of the Fund?
Does the disclosure include a clear outline of the responsibilities
of each stakeholder?
Are price sources for each instrument type disclosed to investors
as well as accounting policies?
Is the cut-off time for formal valuation of the portfolio disclosed?
Granularity
What is the level of detail of disclosure?

Are Fund stakeholders prepared to disclose or discuss the valuation of
every position in the portfolio?
Do Fund stakeholders prefer to disclose percentage bandwidths for pricing
sources used?
Are Fund stakeholders prepared to disclose the precise number of overrides
by the Investment Manager accepted by the Governing Body in a given
period?
Frequency
How often is disclosure made?

For positions valued according to a model designed by a third party or
Investment Manager, how often should investors be updated about the
models assumptions?
How frequently should hedge funds allow investors access to question those
responsible for its valuation process?
Delay
How much of a time lag is there between the occurrence and the
disclosure of events in the valuation process?
If there has been a material change in the valuation policy of a Fund, how
long is it before investors are informed?
If Fund stakeholders provide detailed disclosure of how the portfolio is
valued on a delayed basis, what degree of delay is acceptable for the
information to be meaningful?
Is it reasonable to expect investors to rely on audited financial statements
only for information on the percentage of hard-to-value instruments in the
portfolio?
12 - Findings on Disclosure for institutional investors in Hedge Funds (2000).The IRC is part of the International Association
of Financial Engineers (www.iafe.org).
34
NAV Reporting 7 - NAV reports should be addressed
formal NAV statement for the period, as
directly to investors by the Adminis-
long as suitable disclosures are made. There
trator, where an Administrator is
should be no room for confusion between
used, and any NAVs produced by
these flash estimates and the formal NAV
the Investment Manager should be
on which the Fund is traded.
qualified as such.
Offering
an
investors, an Investment Manager undertakes
indication as to the frequency of NAV
to provide a month-end estimate for a Fund.
reporting, which will be at least as frequent
These estimates are accompanied by clear
as dealing days. Typically, a formal NAV will
disclosures that they are based on the
be
Documents
calculated
at
usually
month-end.
Investment Managers own unverified price
Administrators are usually bound by their
sources and that the official NAV will be
Service Level Agreement with the Fund to
produced
produce and disseminate the NAV within an
independent Valuation Service Provider at a
agreed
later date.
timescale
each
give
Because of the requirements of its
after
month-end.
and
disseminated
by
the
Increasingly, Administrators are developing

web-based reporting infrastructures that
An Administrator who acts as Valuation
can be directly accessed by investors.
Service Provider completes its production of

a Funds month-end NAV and then sends an
There should be as little scope as possible
NAV spreadsheet to the Investment Manager
for the manipulation of a Funds NAV once
on the grounds that the Manager is best
the
been
placed to distribute it to the most relevant
completed. When the Administrator is also
investor contacts. The Investment Manager
the Valuation Service Provider of the Fund,
then reserves the right to amend the NAV
it should be the party which disseminates
before sending it to investors.
formal
NAV
process
has
the month-end NAV. When a division of the

Investment Manager is the Valuation Service
Provider, there should be controls in place
to ensure that the NAV cannot be amended
by unauthorised personnel once it has been
finalised.
Investment Managers may wish to give
investors an idea of performance before the
completion of the formal NAV process. In
such cases, preliminary indicative estimates
may be sent directly to investors by the
Investment Manager prior to the final
35
Recommendations
on Procedures,
Processes &
Systems
37
Processes & Systems
Segregation of Duties 8 - The procedures enshrined in the
calculation before its release to investors,
Funds Valuation Policy Document
as long as any objections they raise are
should be designed to ensure that the
made through the proper channel such as a
parties
Valuation Committee.
controlling
the
Funds
valuation process are segregated

from the parties involved in the
As discussed under Recommendation 3, the
Funds investment process.
usual way in which a Governing Body will

achieve segregation of duties in the
At
the
Investment
segregation
38
of
duties
Manager,
clear
valuation process is to delegate the
between
those
determination of the Funds NAV to an
responsible for investment decisions and
independent Valuation Service Provider,
trading (front office) and those responsible
with clear procedures enshrined in a
for trade settlement, portfolio recon-
Valuation Policy Document.
ciliations and accounting (back office)
way in which the Valuation Service
should be a control in place for a number of
Provider verifies instrument prices will
operational reasons.
The precise
As already stated,
vary from Fund to Fund. For each position
these controls become all the more
in the portfolio, the Valuation Service
important when the back office of the
Provider will usually be responsible for
Investment Manager is in effect the
supplying prices from at least one of the
Valuation Service Provider. There should be
sources listed in the Valuation Policy
a dedicated team responsible for valuation
Document, so that it can check the
which has no involvement in any investment
variance with the other sources. The
process. Team members should be the only
crucial point is that the Valuation Service
members of staff authorised to input prices
Provider should control the process of
directly
portfolio
reconciling price sources with no unsolicited
accounting system. In the normal course of
interference from the Investment Manager.
business, they should also be responsible for
A Prime Broker acts as custodian of the
sourcing quotations from brokers and
Funds assets; an independent Valuation
counterparties, and for inputting data into
Service Provider might be described as
pricing models if they are used. The Funds
custodian of the asset valuation process.
Valuation Policy Document should make
Formal intervention by the Investment
clear the circumstances in which the front
Manager
office may become involved in the process.
process should not be permitted but,
An emphasis on segregation of duties does
after its own review of the Valuation
not imply that front-office professionals at
Service Providers NAV calculation, the
the Investment Manager will never be
Investment Manager may request a price
consulted about valuation issues. It is also
override
entirely sensible for them to review an NAV
outlined under Recommendation 4.
into
the
Managers
in
the
NAV
following
reconciliation
the
procedure
Processes & Systems
Acting as Valuation Service Provider for a
1. Thinly
traded
instruments
Fund, a dedicated back-office team is
exchange-traded
responsible for sourcing or modelling all
existent or unreliable
prices
prices
may
where
be
the
2. Complex
Investment Managers portfolio accounting
Derivatives
system. No members of the front office are
3. Private equity or quasi-private equity
allowed involvement in the process unless,
positions
and
entering
them
into
Over-the-Counter
non(OTC)
in accordance with the Valuation Policy

Document, either the back office ask them
For the first category, the Investment
to help procure a specific quotation from a
Manager may furnish the Valuation Service
broker or they are making a formal
Provider
deposition to the Valuation Committee in
Recommendation 13) or a report on recent
relation to a complex or illiquid instrument.
trading activity which provides evidence for
with
broker
quotations
(see
its view of fair value. For OTCs, the

For the production of a Funds month-end
Investment Manager will usually be able to
NAV, the Investment Manager e-mails the
provide supporting details of its own model-
independent Valuation Service Provider a
based calculations (see Recommendation 14).
portfolio valuation. The Valuation Service

Provider spot-checks this valuation but uses
The need for supporting evidence can be
it as the basis for the formal NAV calculation
more pronounced for positions where a Fund
without
has provided finance to a private company in
sourcing
or
modelling
prices
return for debt or equity.
independently.
An Investment
Manager may illustrate its view of the current
Supporting Information 9 - The industry recognises that in
fair valuation with peer-group revenue
certain instances the Investment
multiple models, reports on recent liquidity
Manager has the best insight with
events for similar positions, discounted cash-
respect to the valuation of particular
flow models, or a weighted combination of
instruments. Wherever prices are
those approaches.
provided
the
private equity valuation, are based on sound
or
sourced
by
Such tools, common in
Investment Manager, the Valuation
economic principles. However, many of the
Service Provider should be furnished
parameters used in such models are
with sufficient supporting information
subjective, and the resulting valuation can
by the Investment Manager.
vary widely depending upon a particular
The typical categories where it may be
risk premia and the probability distribution of
accepted by the Governing Body that the
future cash-flow estimates.
investors perspective of the current market
Investment Manager will be the primary

source for the valuation of a particular
If the Fund is expected to invest in private
instrument are as follows:
positions on a regular basis, the Valuation
39
Processes & Systems
Policy Document may enshrine a procedure
required standards of documentation for
such as discussion of each investment at a
private investments.
monthly Valuation Committee meeting.
Practical Implementation The minutes of this meeting would be
10 - Procedures described in the
provided to the Valuation Service Provider
Valuation Policy Document of the
as supporting evidence for current fair
Fund must be capable of practical
value. Such a procedure may be backed up
implementation by the Valuation
by a periodic written report from an
Service Provider.
independent pricing specialist.

Before a Valuation Service Provider accepts
If there is inadequate documentary support
the Fund as a contracting party, it must
for an Investment Managers valuation
ensure that it can implement the valuation
which the Valuation Service Provider cannot
policies as described and that its systems
validate by other means, the matter should
can access and process the pricing sources
be escalated to Governing Body level.
and models to be used for each instrument

type.
Sufficient time should be given to
A Funds Valuation Policy Document
Valuation Service Providers to undertake
clearly specifies two price sources for each
the necessary due diligence when the other
instrument type, and confers responsibility
Fund stakeholders are unknown to them.
for verifying the sources to the Valuation
They should be consulted about the draft
Service Provider. Because the great majority
Valuation Policy Document as early as
of instruments in the Funds portfolio are
possible during the inception of the Fund (a
exchange-traded, sourcing is not expected
minimum of several weeks prior to launch)
to be complex. If any price is provided by
and the Document should ideally be
the Investment Manager for any instrument
finalised before launch of the Fund.
this is an automatic matter for escalation to

Valuation Committee level where the
The
Manager will be expected to provide
facilitate the preparation of the Valuation
supporting documentation to the satisfaction
Policy
of the Committee.
valuation procedures which the Governing
Valuation
Service
Document
by
Provider
issuing
may
standard
Body, in consultation with the Investment

For a number of private positions, the
Manager, may accept are appropriate for
Investment Manager provides the Valuation
the Fund after due consideration. For more
Service Provider with a scribbled fax giving
complex portfolios, procedures over and
nothing
above the standard will be agreed.
more
than
its
recommended
valuation, without any supporting docu-
40
mentation. The Valuation Service Provider
All stakeholders should be comfortable before
accepts these prices despite the Valuation
launch that the procedures enshrined in the
Policy Document clearly outlining the
Valuation Policy Document are realistic and
Processes & Systems
can be carried out by the designated party in
representations as appropriate and the
practice. It may, for example, be assumed
Document is suitably revised before the
that a Valuation Service Provider can source
launch of the Fund.
two broker quotations for distressed debt

positions by itself. If this is not in fact the case
An Investment Manager intends to launch
and ongoing involvement from the Investment
a new Fund because it has decided to begin
Manager is required to encourage the brokers
trading a new complex strategy in as rapid a
to co-operate, it is better to enshrine a
timeframe as possible. Details of the
workable but robust procedure into the
proposed valuation policies reach the
Valuation Document (such as the copying of e-
Valuation Service Provider a mere forty-eight
mails to the Valuation Service Provider) rather
hours prior to the launch of the Fund. The
than insisting on a more rigid policy which
Valuation Service Provider is persuaded to
means that in practice virtually every position
accept the engagement before it is satisfied
priced off broker quotations would have to be
it can implement procedures outlined in the
escalated for review by the Governing Body.
draft Valuation Policy Document.
Consistency of Application One important issue for the Valuation Service
11 - The Valuation Service Provider
Provider (whether it is independent of the
should use reasonable endeavours to
Investment
the
apply any pricing policy consistently.
competence of staff detailed to the valuation
Deviations from the policy should be
process. If complex instruments types are to
approved by the Governing Body in
be added to the Funds investment mandate,
advance of any NAV being released.
Manager
or
not)
is
the Valuation Service Provider should ensure

that sufficient training has been given to staff
A crucial component of the Valuation
assigned to work on those instrument types.
Service Providers processes will be to check
The Governing Body should monitor the
that the price sources for each instrument
adequacy of staff training in its ongoing
type as outlined in the Valuation Policy
reviews of the Valuation Service Provider. If
Document are being consistently applied
the Valuation Service Provider is effectively
(see Recommendation 12). The Valuation
the back office of an Investment Manager, the
Service Provider may also conduct further
firms compliance function may perform such
checks on the consistency of valuation,
a monitoring role as part of its general
using the following tools:
oversight of staff training and competence.

1. A stale price report which highlights any
As part of the set-up process of a Fund, the
instrument where the price has remained the
Governing Body circulates a draft Valuation
same month-on-month. The instruments on
Policy Document to the Investment Manager,
this list would then be investigated further
the Valuation Service Provider and the Auditor.
to ensure that the price is not out-of-date
All
and that the valuation is appropriate.
parties
are
given
time
to
make
41
Processes & Systems
any variances over a set percentage from
names a specialist vendor as the primary
the previous month-end NAV.
Again, the
source for bank debt. One month-end the
instruments on this list would then be
vendor cannot furnish a price for a
investigated to ensure that the large price
particular position. In consultation with the
movements month-on-month were genuine.
Investment Manager, the Valuation Service
3. Valuation Service Providers may also be
Provider finds another specialist vendor who
able to run a report listing instrument
can provide a valuation. The matter is put
prices from sources other than those listed
on the agenda for the Funds monthly
in a Funds Valuation Policy Document which
Valuation Committee meeting and the price
can
from the alternative source is approved for
highlight
any
material
variances
between the average of all sources.
inclusion in the month-end NAV.
There should only be rare instances where a
Although the Valuation Policy Document
Valuation Service Provider decides not to
gives it no such authority, an Investment
apply a pricing policy enshrined in the
Manager seeks to have full discretion over
Valuation Policy Document. For example,
the level of a liquidity discount factor each
the Document may state that the bid/ask
month, without any reference to the
spread of an instrument should be obtained
Governing
and the midpoint used for valuation, but in
Provider.
practice only the bid price may be

available.
Even if the Valuation Service
Provider and the Investment Manager agree

that a deviation from the usual policy is
acceptable, this fact should ideally be
escalated to the Governing Body for
approval.
Circumstances may also arise where new
instruments are created and therefore do
not yet have an official policy incorporating
them. In the case of new instrument types,
the Governing Body should formulate a
written policy as soon as practicable. Some
Valuation Service Providers have internal
procedures which do not allow them to
accept a deviation from the documented
policy without receiving a written
resolution from the Governing Body.
42
2. A large variances report which highlights
Body
or
Valuation
Service
Recommendations
on Sources,
Models &
Methodology
43
Models & Methodology
Multiple Sources 12 - Wherever possible the valuation
Investment Managers own marks will still be
of each position in the Funds
used as a reasonableness check.
portfolio should be checked against a
course of the work they perform for their
primary and secondary price source.
range of clients, Valuation Service Providers
The
may
Valuation
Policy
Document
also
receive
prices
for
In the
certain
should outline the hierarchy of
instruments drawn from various other
sources to be used for each security
sources such as counterparty statements,
type and the tolerance levels for
broker
variances between the sources.
aggregators
quotations,
and
feeds
reports
from
from
data
pricing
specialists. One or more of these may be

For exchange-traded instruments, prices
cited in a Funds Valuation Policy Document
tend to be sourced from recognised vendors
as secondary sources.
of market information.
Most Investment
prove impossible to find a reliable second
It may of course
Managers and Valuation Service Providers
price source. An example would be a private
have direct feeds from one or more of these
position where the Investment Manager is
vendors. The principle of checking each
the only party competent to produce a best
position against at least two price sources is
estimate of fair value. If such positions form
advisable, even for instruments which are
a material part of a Funds NAV, suitable
normally easy-to-value.
disclosures should be made following our
There is clearly
more chance of picking up a one-off error
transparency recommendations.
caused by a faulty input or feed (mistakes

sometimes euphemistically referred to in
Depending on the type of instrument being
the industry as data exceptions) if there
priced, the Governing Body of a Fund, in
is another source against which to check the
consultation with the Valuation Service
primary source. Given the number of data
Provider and Investment Manager, can
vendors, the valuation of exchange-traded
define in the Funds Valuation Policy
instruments should not be based on only
Document the hierarchy of price sources to
one price source.
be used, with appropriate tolerance levels

if there is a discrepancy between the
44
It is in fact sound practice for a second
primary and secondary source.
pricing source to be sought for all positions
tolerance levels used may depend upon the
in a portfolio. For instance, the valuation
instrument
of an OTC derivative will often be derived
normally be measured both in terms of the
from
pricing
model,
but
type,
but
variances
The
will
the
percentage difference between the sources
counterpartys valuation can be employed
and the basis points impact on overall Fund
as a secondary source. In another example,
NAV. Some Valuation Policy Documents also
the Governing Body may approve the
specify a dollar amount over which any
outsourcing of mortgage-backed securities
variance should be escalated for the
valuation to a pricing specialist, but the
Governing Bodys review.
states
that,
for
all
exchange-traded
the quotations provided are the most

accurate and relevant.
securities, the price from a defined primary

market vendor source should be used,
The Governing Body of a Fund may
unless the price from a defined secondary
therefore establish a policy in the Valuation
source gives a variance over a set tolerance
Policy Document stating that, if a valuation
level. The Valuation Policy Document also
for a security cannot be sourced from either
outlines an escalation process for the
of the Funds chosen market data feeds, or
resolution of any material variances.
if a Valuation Committee agrees that

market data is unreliable given the size of
Because of time pressure a Valuation
the Funds position or the low frequency of
Service Provider bases portfolio valuations on
trading, broker quotations may be used as a
a single source (a Prime Brokers report,
primary source.
despite the disclaimers provided by the Prime

Broker).
The Valuation Service Provider
performs no further verification work.
The
minimum
number
of
quotations
required and the method of calculating an

average price may depend on the nature of
Broker Quotations 13 - If the Governing Body approves
the instruments. In some cases, a simple
the use of broker quotations for the
mean
valuation of certain instruments, all
calculated; another procedure, if five or
reasonable efforts should be made to
more quotations are available, is to discard
ensure that these quotations are
the outliers and then to calculate an
multiple, sourced consistently and
average (of ask, bid or mid price as
of
accessed by the Valuation Service
stipulated
Provider
Document).
independently
intervention
by
the
without
the
in
quotations
the
received
Valuation
is
Policy
Investment
Manager.
When
broker
sources
are
used,
the
Valuation Service Provider should procure

For thinly traded or illiquid securities,
month-end quotations directly from those
especially convertible bonds, distressed and
sources. In practice, some of the larger
high-yield debt, quotations from market-
Valuation Service Providers receive multiple
makers (usually brokers) may sometimes be
quotations in the course of other NAV
deemed the sources most fully reflective of
exercises, and log them onto a database or
fair value.
other system. It is recognised that in certain

circumstances the Valuation Service Provider
The main issues when broker quotations are
lacks sufficient leverage over the broker to
used are to ensure as much independence
ensure a quotation is sent directly. In these
from the Investment Manager as possible in
cases it is sometimes possible for the
sourcing the quotations and to ensure that
Valuation Service Provider to be copied in
45
directly on e-mail correspondence so that it
Governing Body, as part of its ongoing
does not have to rely on information
monitoring of valuation procedures, may
forwarded by the Investment Manager. Some
wish to receive a periodic report comparing
third party vendors also provide services
prices achieved on the sale of thinly traded
aggregating market-maker quotations for
instruments with their most recent formal
asset classes such as bank debt.
valuations before sale if derived from

broker quotations.
In normal circumstances, quotations from

the same brokers should be used at each
month-end to ensure consistency in the
states that convertible bonds for which no
valuation of the relevant instruments. It is
reliable market data exists will be priced at
not sound practice, in cases where it has
the
been customary for two or three brokers to
quotations. Any change to the named
provide the month-end quotations for a
brokers must be approved in writing by the
particular instrument, for another source to
Governing Body, and the Valuation Service
be suddenly substituted without proper
Provider will make best endeavours to
explanation
source the quotations directly.
and
consultation.
The
mean
of
three
named
broker
Investment Manager may have entirely

legitimate reasons for recommending that a
Members of the Investment Managers
certain broker should be used because it has
front office enter into a Funds portfolio
started to cover a particular instrument, or
accounting system valuations for a number
that a particular quotation should be
of high-yield bonds on the basis of the
discarded because the broker in question
broker quotation they feel best reflects
has been providing spreads which would
the fair value of the securities. The back
change materially if the Fund actually
office, acting as Valuation Service Provider,
attempted to trade. These reasons should
has no transparency for the quotations used
be documented to the satisfaction of the
and no way of ascertaining whether they
Governing Body as a control against possible
are from consistent sources.
cherry-picking of broker sources by the
Pricing Models Investment Manager.
14 - Any decision to use a pricing

model should be approved by the
It is also important to ensure that the
Governing
quotations
merely
properly justified by appropriate
indicative but are meaningful in the context
testing. If an Investment Managers
of the Funds total holding in an instrument.
pricing models are used they should
The Investment Manager is usually best
be independently tested and verified.
received
are
not
Body
and
should
be
placed to have an opinion if a quotation
46
from a market-maker is unrealistic for a
For derivatives traded over-the-counter
transaction of any volume.
between two counterparties, the absence of
However, the
a secondary market means that the standard
documentation of the approval process may
method of valuation will be a pricing model.
include:
Models may also be used as a primary source

for complex derivatives or instruments with
1. The reasons for using a pricing model
an element of optionality where other
rather than a market price (typically
sources are considered unreliable.
because of the unavailability or inaccuracy

of an exchange-traded mark).
Pricing models are becoming more complex
2. The reasons for the choice of a particular
and may require a significant level of back-
pricing model as opposed to alternative
testing and independent verification prior
models (typically with a review of the
to being used as a valuation tool. In some
advantages and disadvantages of the
instances, a pricing model may have been
models under consideration).
designed to value a certain type of financial
3. An appraisal of the strengths and
asset, and over time may be modified to
weaknesses of the pricing model used, and
incorporate more exotic types of financial
its consistency with the Funds established
instruments, causing possible weaknesses
valuation policies. If the pricing model in
and workarounds.
question is an off-the-shelf solution from

a model vendor, references from reliable
The Funds Governing Body, as part of its
third parties may be procured. If the model
oversight of the entire valuation process,
has been internally developed by the
should approve any decision to use a pricing
Investment Manager, an independent expert
model as a formal valuation source for any
may report its findings.
part of the portfolio. Such oversight is
4. Defined procedures outlining who will be
particularly important if the model used has
responsible for inputting data to the model
been developed by the Investment Manager,
and
or if the model will be used as a primary
calculation (especially if there is any
source in preference to a quotation on a
subjective element to the interpretation of
recognised exchange. The Governing Body
the data or the method of calculation).
will typically seek representations from the
5. An escalation process should the
Investment Manager and/or vendor of the
valuations produced by the model fall out of
model, as well as the Valuation Service
Provider if the Valuation Service Provider
compared to an alternative pricing source
will be using the model for production of
such as a counterparty quotation.
the month-end NAV.
guidelines
prescribed
for
the
tolerance
method
range
of
when
The Governing Body
may seek the opinion of an independent
Although there may not always be complete
expert it is sound practice for them to do
consensus as to whether a pricing model is
so if the model has been developed
industry standard, the Governing Body
internally by the Investment Manager and is
may note that stakeholders such as the
material to the NAV. In any event,
Investment Manager, Prime Broker and
47
Before the launch of a Fund, the
Valuation Service Provider are comfortable
with the model in question. In practice, the
Governing Body reviews pricing models for
more straightforward OTC contracts would
complex variance swaps. It decides, after
include interest rate swaps, equity swaps,
consultation with the Investment Manager
foreign exchange options and many credit
and the Valuation Service Provider, that the
default swaps. For these instruments,
preferred model is currently not reliable
pricing models with readily available data-
enough to be used as a primary source. It is
input parameters are routinely used by
therefore stated in the Valuation Policy
market counterparties.
Document that the model will be a source

secondary to a counterparty quotation until
More complex OTCs include long-dated out-
such time as the Governing Body approves it
of-the money swaptions, long-dated equity
as a primary source.
index options, some variance swaps, credit

default
swap
options,
synthetic
On the grounds of immateriality, a
and
Governing Body allows an over-the-counter
mortgage-backed derivatives. Valuation
derivative not previously traded by the
models exist for these types of instrument
Fund to be valued according to a pricing
but the assumptions and data inputs used
model
are likely to involve subjective judgement.
Manager. However it then fails to approve
In certain circumstances, it may be agreed
the pricing model formally, so that the
that counterparty quotations will be used as
model continues to be used on a month-to-
a primary source, although every effort
month basis without proper scrutiny by the
should be made to approve a model as the
Governing Body and without the Valuation
primary source.
Policy Document being updated to take
collateralised
debt
obligations
developed
by
the
Investment
account of the new derivative product.

Once a model has been adopted by a Fund,
Side Pockets its outputs should be monitored against
15 - Any decision to allow the side-
other sources. The most obvious of these is
pocketing of illiquid/hard-to-value
the counterparty mark, but it is also useful
positions should be taken only after
to compare the realised proceeds once a
careful consideration by a Funds
derivative contract is unwound to a
Governing Body.
contemporaneous valuation by the model if
Body approves such a decision it
this has been recorded.
should
The Investment
ensure
If the Governing
that
side-pocket
Manager and Valuation Service Provider may
policies are clearly communicated to
also have access to other models for the
all investors. The criteria for side-
same type of derivative.
pocketing individual positions should

be as consistent as possible.
48
The fact that investors in a hedge fund
There are a number of variations in side-
regularly subscribe and redeem on the basis
pocket
of a formal NAV means that the cost
practice of hedge funds is that only those
accounting methods typically used by private
investors who hold a position in a Fund at
equity funds are not necessarily appropriate
the
for material holdings in private or quasi-
designated for a side pocket are permitted
private investments. On the one hand, a
to participate in the subsequent gain or loss
policy which does not revalue a private
when the position is eventually realised.
position upwards from cost (until a tangible
Investors hold a separate class of shares for
event) protects investors from the possibility
each side-pocket transaction, which can be
that valuations where subjective judgement
redeemed
only
is required may be unintentionally or
occurred.
Investment Managers do not
deliberately overstated. On the other hand,
usually receive a performance fee on the
if there is no attempt to fair-value a private
side-pocket share classes until this moment
investment for a prolonged period, investors
of crystallisation. In some hedge funds,
who redeem from the Fund in the interim
participation in side pockets is mandatory;
will not be treated fairly.
others allow investors to opt out of side
methodologies
time
pockets;
that
others
when
the
realisation
give
term
participate on a case-by-case basis.
is
becoming
decide
investors
opportunity
which
usual
transaction
A method of dealing with the issue of longilliquidity
to
the
but
whether
was
has
the
to
increasingly prevalent in the industry is the

use
of
side-pocket
share
classes,
sometimes known as Special Situations or

Class S shares.
Under side-pocket methodology, financial
assets that are removed from the valuation
process applied to the rest of the portfolio
are held either at cost or at estimated fair
value (depending on the Funds valuation
policy for the side pocket) until either a
liquidation, a flotation, a third party sale or
some other event which points to clear
evidence of current fair value.
49
Advantages
Disadvantages
Arguments for and
1. The nature of side-pocketed positions is
1. There
against side pockets
that their returns tend to be j-curved,
psychological motivation for Investment
even when they are fair-valued on a
Managers
periodic basis. In other words, a catalyst or
pocketing of positions not solely on the
exit route is usually required for the value
grounds of illiquidity or the complexity of
embedded in the position to be realised.
valuation, but because the Manager thinks
The side-pocketing of these positions at
the risk may be on the downside and
inception ensures that current investors in
prefers not to have the position included
the Fund are not diluted by later investors
in the main Funds reported performance
who may gain exposure to the position at a
and volatility.
conservative
2. Especially
valuation
that
does
not
necessarily represent fair value.

2. By
side-pocketing
very
may
to
be
an
economic
recommend
if
the
the
positions
or
side-
are
immaterial, the administration of the

illiquid
side-pocket
share
classes
can
be
positions, the Investment Manager can
unjustifiably burdensome for the Adminis-
still offer their investors exposure to
trator, Investment Manager and investors
interesting
alike.
long-term
ideas
without
compromising the headline liquidity of
3. Certain categories of investors find side
the Fund itself.
pockets very hard to accommodate in
3. The valuation issue for a private position,
portfolios because of their indeterminate
where some kind of model will probably
duration. The investment mandates of
be used and subjective judgement will be
these investors may proscribe holdings in
required, will largely fall away if the
underlying funds which have worse than
position is ring-fenced from the rest of the
quarterly liquidity, but side pockets may
portfolio and no performance fee is
take years to liquidate.
charged until the position is realised. (Of
4. All these disadvantages are exacer-
course the Investment Manager and other
bated if side-pocket participation is
stakeholders will continue to fair-value
mandatory.
the position informally).
50
The introduction of side-pocket provisions
the Investment Manager and the Valuation
into a Funds constitution is a material
Service Provider. If it is decided that side-
change and should be given very careful
pocket classes are to be a feature of the
consideration. A Governing Body should weigh
Fund, the mechanisms surrounding them
up the advantages and disadvantages of side
should be clearly disclosed in the Funds
pockets, in the context of its particular Fund,
Offering Document (as mentioned under
and may wish to consult investors as well as
Recommendation 5).
The Governing Body
should also have formulated and disclosed
For a Fund with existing side-pocket
its policies on opt-outs, fee-charging
provisions the Governing Body accepts an
arrangements and the maximum percentage
Investment Managers request to side-pocket
of Fund net assets allowed in side pockets.
an exchange-traded position (which has

already been in the portfolio for some time)
It is difficult to propose prescriptive rules for
on the grounds of general illiquidity.
each specific decision to side-pocket an

investment, because subjective judgement
will always be required.
However, the
Governing Body should aim for as much

consistency as possible in its criteria for sidepocketing and should require the Investment
Manager to justify any request to side-pocket
a position.
Factors to be considered will
include the materiality of the position, the

fair value measurements available, the likely
time horizon to realisation of the investment
and the nature of exit strategies. Particular
scrutiny should be given to proposals to sidepocket a position which is already in the
Funds portfolio.
A Governing Body, after consultation
with the Investment Manager, notes that
the number of private or quasi-private
positions in the portfolio is likely to be
immaterial in the context of the Fund
overall. It also takes steps to ensure that
the Valuation Policy Document contains
details of the fair value methods, or
combination of methods, which may be
used to price such positions. It therefore
concludes that side-pocket classes will not
be required, reserving the right to review
the situation if the number of private
positions increases or if fair value models
prove consistently unreliable.
51
Appendix 1:
About AIMA
53
About AIMA
The Alternative Investment Management
- Guidance on Capital Adequacy requirements
Association (AIMA) is the not-for-profit
- Submissions to regulators and other
global hedge fund association with over
authorities around the world on their hedge
1,100 corporate members in 47 countries.
fund consultations, regulation and tax

inplementations.
Members include leading hedge fund

managers, fund of hedge funds managers,
AIMA is committed to developing industry
prime brokers, legal and accounting service
skills and education standards and is a proud
providers and fund administrators.
They
co-founder of the Chartered Alternative
benefit from AIMAs active influence in
Investment Analyst designation (CAIA) the
policy development, its leadership in
industrys
industry initiatives, including education and
educational
sound practice manuals and its excellent
investment specialists.
first
and
standard
only
specialised
for
alternative
reputation with regulators, worldwide.

Enhancing understanding, sound practices
AIMA is a dynamic organisation that reflects
and industry growth
its memberships interests and provides
www.aima.org
them with a vibrant global network.

Key projects created and distributed by
AIMA include:
- Series
of
illustrative
due
diligence
questionnaires for the selection of managers

and service providers (available to AIMA
members and institutional investors)
- Guides to Sound Practices for European,
Canadian and Asian Managers
- Guide to Sound Practices for Hedge Fund
Administrators
- Offshore Alternative Fund Directors Guide
Additionally, AIMA serves as the voice of the
industry
throughout
the
world
with
regulators and other authorities, holding its

international regulatory forum every other
year. Specific output includes:
- Guide to MiFID
- Regulatory and tax snapshots of the
industry in over 30 countries,
54
Appendix 2:
AIMA Asset
Pricing
Committee
55
AIMA Asset Pricing Committee
Co-chair
Olwyn Alexander*
PricewaterhouseCoopers
Co-chair
Kieran Conroy*
Citco
Chief editor and author
David Woodhouse*
Fauchier Partners
Authors
David Aldrich
Bank of New York
Evans Apeadu
Balysny Europe Asset Management

(previously at RAB Capital Plc)
Rebecca Berlow
Morgan Stanley
Jerome Barraquand
GlobeOp
Olivier Champagne
Straper
Guy Clayton
Morgan Stanley
Hugh Crehan
KPMG
Simon Firth
Kaye Scholer
Tim Fletcher
Semper Macro
Daniel Harris*
D Harris & Co
Elsa Heitzig
JP Morgan Hedge Fund Services

(previously at DPM Mellon)
Co-ordinator
Joseph Henkel
SEI
Andrew Johnston
Man Investments
Mike Ketley
Caliburn Capital Partners
Julian Korek
Kinetic Partners
Gerald Lins
ING Alternative Asset Management
John Maltby
DKR
Barry Rome
Kinetic Partners
Christopher Rose
Lombard Risk
Karen Tyrrell
Bisys
Emma Mugridge
AIMA
* Contributors to AIMAs 2005 study on Asset Pricing and Fund Valuation in the Hedge Fund Industry
We are most grateful to those individuals who reviewed the Guide, including:
Alain Reinhold, ADI Alternative Investment
Jim McGovern and Rob Maxwell, Arrow Hedge Partners, Inc
Shinichiro Shiraki, Asuka Asset Management, Ltd
Justine Lee, Colonial First State Investment Managers (Aus) Ltd
Peter Douglas, GFIA Pte. Ltd
Jeff Landle, Hardt Group Advisors, Inc.
Kok-Ying Lee, LaCross Global Fund Services
Christian Thompson and Suzanne Pattison, Man Investments
Melissa Hill, Sabre Fund Management Ltd
The Guide was also reviewed by a further four fund of hedge funds managers, six hedge fund managers,
two auditors and one pension fund. The Reviewers are based throughout Asia, Europe and the USA.
56
Appendix 3:
Hedge Fund
Stakeholders
57
Hedge Fund Stakeholders
Stakeholder
Definition
Typical involvement in valuation process
ADMINISTRATOR
An entity, usually independent of the
In the majority of cases, the Administrator
Investment Manager, who provides a range of
acts as Valuation Service Provider as part of its
services to the Fund under the terms of an
services to the Fund.
agreement with it (often in the form of a

Service
Level
Agreement),
including
Note that if the Administrator is described as
shareholder services, registrar and anti-money
an NAV Calculation Agent, it is not a
laundering services, reconciliation services
Valuation Service Provider but merely carries
and
Some
out an arithmetical check on an NAV produced
Administrators offer integrated solutions
record-keeping
functions.
by another party (usually the Investment
which allow Investment Managers to outsource
Manager). In such a situation, the Investment
some of their own back-office functions.
Manager would be responsible for the

determination of the Funds NAV with no
meaningful input from the Administrator.
The Administrator may also be described as
providing an NAV Lite service.
In these
situations, the NAV of the Fund is essentially

determined by another party (usually the
Investment Manager) and the Administrators
role is to review the calculations for
reasonableness. Again, the Administrator is
not acting as a Valuation Service Provider
according to AIMAs definition.
AUDITOR
The Auditor issues a written opinion upon
The audit involves a review of the Funds
the fair presentation of the Fund's annual
valuation policies and procedures at year-
financial statements, in accordance with
end, and, depending on the risk assessment
the Fund's applicable accounting and
by the Auditor of material misstatement,
auditing standards, on the basis of a year-
would
end audit of the Fund's books and records.
substantive testing of position valuations.
normally
include
level
of
The audit opinion cannot be relied upon as

a full verification of a Fund's formal NAV
throughout the year, although in conducting
its procedures the Auditor will review the
valuation policies and procedures in place
during the period under audit. The Auditor
may provide other attestation services at
the request of the Fund's Governing Body.
However, independence must always be
maintained by the Auditor in accordance
with the applicable standards, which may
58
vary by jurisdiction.
Stakeholder
Definition
CUSTODIAN
A bank, trust company or other financial
While a Custodian has an important role to
institution that holds and protects a Funds
play in verifying the existence of investments,
assets and provides other services, including
it is unusual for them to become involved in
collecting money from investors, distributing
the formal NAV process.
redemption proceeds, maintaining margin

accounts,
registering
investments
and
Custodian
statements
commonly
report
exercising options. Usually a Funds Prime
market values but often contain disclaimers as
Broker(s) will perform the role of Custodian.
to the accuracy of the values or reliability for

the purposes of Fund accounting.
FUND
The Fund is a collective investment scheme,

typically established in the following ways:
1. In offshore jurisdictions such as the
Cayman Islands, the Fund will usually be
established as a Limited Liability Company.
2. Funds established under the laws of a US
state such as Delaware usually take the
form of a Limited Liability Partnership.
3. Some Funds in offshore jurisdictions are
established as Unit Trusts, although this is a
comparatively rare structure.
The Fund has legal identity but in practice
decisions on its behalf will be made by its
Governing Body.
59
Stakeholder
Definition
GOVERNING BODY
A Governing Body generally supervises and
The Governing Body will have overall
oversees the conduct of its Funds affairs, even
responsibility for the valuation of the Fund. It
though it will delegate day-to-day functions to
will typically delegate day-to-day respon-
other parties such as the Investment Manager
sibility for the production of the NAV to a
and Administrator.
Valuation Service Provider.
The composition of the Governing Body will
Note that, in Partnership structures, the
depend upon the Funds structure and
General Partner (and therefore the Governing
jurisdiction:
Body) may be the Investment Manager.
In
these circumstances a Valuation Committee is

1. A Fund established as a Company will have
often established to oversee the valuation of
a Board of Directors as the Governing Body.
the Fund.
The Board may include representatives of the

Investment Manager, and directors selected by
the Investment Manager, although there is an
increasing trend for independent nonexecutive directors of stature to be appointed
to hedge fund Boards.
2. A Fund established as a Partnership will
usually have a General Partner as Governing
Body. Typically the General Partner will be the
Investment Manager.
3. A Fund established as a Trust will have a
Trustee as the Governing Body. The Trustee is
usually an independent licensed company.
INVESTMENT MANAGER
Often referred to as the Investment Advisor
1. In a minority of cases the Investment
in the United States.
Manager will act as the Valuation Service

Provider (sometimes referred to as self-
The Investment Manager enters into an

agreement
with
the
to
make
investment decisions on its behalf, usually
2. For portfolios with a hard-to-value
on a discretionary basis, in return for a
component, the Investment Manager is
management fee (based on NAV) and a
likely to have material input into the
performance fee (a percentage of NAV
valuation process and may be the primary
appreciation over a given period). The
source
performance fee is sometimes also referred
positions.
to as an incentive fee.
60
Fund
administration).
for
the
valuation
of
certain
Stakeholder
Definition
INVESTOR
Investors in hedge funds can be categorised in
Investors, especially fund of hedge funds
many ways but the most clear distinction is
managers, may perform due diligence on the
between fund of hedge funds managers and
integrity of a Funds valuation process, but
direct investors:
they will not be involved directly in the formal

NAV process.
1. Fund of hedge funds managers:
These
entities manage diversified portfolios of hedge

funds (usually in the form of collective
investment schemes), and provide their
investors with services such as fund selection
and risk management in return for a fee.
2. Direct investors: Hedge funds are aimed
primarily at institutional and sophisticated
investors. Direct investors include pension
funds (public and private), endowments,
foundations and family offices.
PRIME BROKER
A large bank or securities firm that provides
Prime
various back-office and financing services
Investment Managers with informal pricing
to hedge funds and other professional
for a Funds portfolio. However, it is unusual
investors. Prime Brokers can provide a wide
for Prime Broker valuations to be relied
variety
upon in the formal NAV process.
of
services,
including
trade
Brokers
will
typically
provide
reconciliation (clearing and settlement),

custody services, risk management, margin
Some Prime Brokers have affiliates who act
financing, securities lending for the purpose
as Administrators and/or Valuation Service
of carrying out short sales, recordkeeping
Providers.
and investor reporting. A prime brokerage

relationship does not preclude hedge funds
from carrying out trades with other brokers,
or employing others as Prime Brokers.
REGISTRAR
The organisation that maintains a registry of

the share owners and number of shares held
for a hedge fund.
Usually the Funds
Administrator also performs the role of

Registrar.
61
Stakeholder
Definition
REGULATOR
Independent
governmental,

organisation,
that
oversees
usually
Regulators may, in their supervisory role,
financial
inspect the valuation procedures and controls
markets, transactions and participants. Often
of those Investment Managers and Valuation
seen as the protector of individual investors.
Service Providers who are under their national
Most, but not all, hedge fund Investment
jurisdiction.
Managers are registered with their national

Regulator.
VALUATION COMMITTEE
Some Governing Bodies delegate oversight
Valuation Committees are a particularly useful
of the valuation process to a Valuation
intermediate oversight body when:
Committee. This may be a sub-committee
1. The Governing Body is the Investment
of the main Governing Body, or a separately
Manager.
constituted Committee.
2. The NAV process is complex and requires

monthly decision-making.
VALUATION SERVICE
Valuation Service Provider is the term used
The Funds Administrator often acts as
PROVIDER
throughout this Document for the party who
Valuation Service Provider, although the role
is primarily responsible for producing the
may be taken by another competent party.
NAV of the Fund in accordance with the

Valuation Policy Document.
For some hedge funds, the Investment

Manager acts as the Valuation Service
Provider.
62
Appendix 4:
Fair Value Accounting Guidelines
63
Fair Value - Accounting Guidelines
What exactly is meant by Fair Value? The
reference market for the asset or liability.
accounting standards and regulators provide
FAS 157 describes three different valuation
the most commonly accepted definitions.
techniques: the market approach, the

income approach and the cost approach.
In Europe, the EU Directive on fair valuation
The sufficiency and quality of data
adopts
by
available to estimate fair value is examined
International Financial Reporting Standards
the
definition
put
forth
in choosing the valuation technique, which
(IFRS) which state that Fair Value is the
must be consistently applied.
amount for which an asset could be
divides the fair value hierarchy into three
FASB also
exchanged between knowledgeable, willing
levels. The first level is directly observable
parties in an arms length transaction.
market prices where there are quotations

for identical assets or liabilities in active
US Generally Accepted Accounting Principles
markets.
Level three investments are
(US GAAP) define fair value in a similar
valued using models with significant entity-
manner as the amount at which an asset
derived inputs (e.g. inputs derived through
could be bought or sold in a current
extrapolation or interpolation but that are
transaction between willing parties, that is,
not corroborated by other market data).
other than in a forced or liquidation sale. The
Level two then covers all other investments
US Investment Company Act of 1940 states
on the spectrum between these extremes.
that the value of securities for which market
It is generally accepted that if an
quotations are readily available is the market
investment is freely traded in a deep,
value, for all other investments the value is as
liquid market the best estimate of fair
determined in good faith by the board [of the
value is the current exchange-traded price.
Company].
However, once the investment moves from

this ideal valuation scenario a number of
The Financial Accounting Standards Board
factors must be considered in determining
("FASB") in the US recently issued FAS 157 to
valuation, which may include:
examine fair value measurement, proposing
64
a single definition of fair value under US
Liquidity
GAAP and providing a framework for how to
Accounting treatments
measure and determine fair value. The goal
Frequency of trading
is to increase consistency and comparability
Currency fluctuations
in estimates of fair value, as well as
Economic/Industry Developments
enhancing transparency through enhanced
Value of similar financial instruments
disclosure.
Changes in interest rates
FASB proposes a revised
definition of fair value as the price that
Reliability of models (if used)
would be received for an asset or paid to
Reliability of input data to models (if used)
transfer a liability in a current transaction
Reliability of estimates
between marketplace participants in the
Reasonableness of assumptions
Fair Value - Accounting Guidelines
In summary, there is broad consensus on the
Determining fair value where no exchange-
definition
the
traded price exists is more of an art than a
determination of fair value can lead to
of
fair
value,
but
science, as a number of assumptions and
divergence in approaches, estimates and
estimates must be made. As a final test in
assumptions which can cause a significant
estimating the fair value of a non-exchange-
variation in the fair value estimate
traded position, it should be benchmarked
produced.
As emphasised in the various
to the definitions above: is the price what
sections of this Guide, it is therefore
one would pay/receive for this investment
essential for a Fund to have a Valuation
in
Policy Document. The stakeholders in the
knowledgeable market participants?
an
arms
length
transaction
with
valuation process should ensure that the

policies are consistently applied and reflect
current sound practice in the industry.
65
Appendix 5:
Valuation Policy
Document Outline
67
Valuation Policy
Document Outline
This outline is for guidance only. The suggestions listed are not intended to be comprehensive; conversely, they will not all
be appropriate in each individual case.
Valuation Policy Document of [NAME OF FUND]

This Document remains the sole property of [NAME OF FUND]. The Policy was prepared by the
[INVESTMENT MANAGER] and [VALUATION SERVICE PROVIDER] of [NAME OF FUND]. The Policy
was approved by the [GOVERNING BODY] on _____________.
Objective
For example:
The Funds valuation policies and procedures are designed to ensure that all instruments are
valued in accordance with the Funds Offering Document. The value of those instruments will
form an integral part of the Net Asset Value calculation on which investors subscribe and
redeem on each and every dealing day. The aim of the policies and procedures is fairness to
all investors in the Fund.
Responsibilities
This section would define the various stakeholders involved and outline their responsibilities:
Governing Body
Valuation Committee (if applicable)
Investment Manager
Valuation Service Provider
Other (e.g. Auditor, independent accountant, pricing specialist)
If an affiliate or division of the Investment Manager is the Valuation Service Provider, the document may be expected to
provide information on the personnel/departments assigned responsibility.
Oversight
This section would set down guidelines for the body responsible for oversight of valuation:
Identity (i.e. Governing Body or Valuation Committee)

Quorum
Normal frequency of meetings
Reports to be presented (e.g. exception reports from Valuation Service Provider)
Outline of approval process for new models/sources
Frequency of review of the Valuation Policy Document
If the Governing Body delegates its oversight function to a Valuation Committee, it may set out in this section matters that
remain reserved for its approval.
This Outline covers Escalation under a separate heading but that subject may also be dealt with here.
68
Valuation Policy Document Outline
Valuation Sources
This section might list a price source matrix, perhaps configured as follows:
Type of Asset
Primary Source
Secondary Source
Accounting
Cut-off
Tolerable
Policy
time
Variance
For certain instruments, there may be a hierarchy of more than two sources.
The Accounting Policy column would typically state which part of any price spread should be used (e.g. bid, ask or mid).
The Document may indicate which party would usually be responsible for accessing each price source.
Notes may be provided if the accounting policy is complicated or if access to a source requires a procedure with several steps.
For more complex instruments, the section may provide guidance such as:
Method of deriving an average price from broker quotes

Data to be input to pricing models (including details of sources, steps in the input process
and the party responsible for input)
Approved pricing specialists (to be consulted if the usual sources are unavailable)
Level of documentation required for private positions
Control Procedures
The size of this section may depend on the complexity of instruments traded, but it could include:
Procedures for back-testing

Definition of stale prices and procedures for isolating them
Monitoring of trading volume for less liquid instruments
Escalation
This section would outline as clearly as possible the Funds escalation procedure if the Investment Manager or other party
requests a deviation from the Funds usual policies:
Definition of an Investment Manager override

Definition of materiality
Governing Body (or Valuation Committee) quorum
Acceptable format and deadline for representations
Timescale for decision
Guidance on possible adjudication/arbitration by pricing specialists
Protocol for minute-taking
The escalation procedures may be used as the basis for a procedure to approve side pockets, should the Fund have side
pocket provisions.
69
Valuation Policy Document Outline
Other
The Document may also address subjects outside the scope of this Guide, such as:
Policies on income recognition, expense accruals and performance fee calculation

Agreed timetables for delivery of NAV reporting
Appendices
Possible appendices may include:
Excerpts from the Offering Document relating to valuation policies

Latest accounting policies note from the audited financial statements
Contact details for all relevant parties
70
The Alternative Investment Management Association Ltd (AIMA)

Meadows House, 20-22 Queen Street, London W1J 5PR
Tel +44 (0)20 7659 9920
www.aima.org
Enhancing Understanding, Sound Practices and Industry Growth

Aima'S Guide To Sound Practices For Hedge Fund Valuation: MARCH 2007

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AIMAS GUIDE

TO SOUND PRACTICES FOR

Appendix 2: AIMA Asset Pricing Committee & Guide Reviewers . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

The full Guide is available for purchase.

any duplication where it may have existed.

industry to drive forward initiatives in order

While a number of Recommendations have

to enhance sound practices.

been combined or condensed they have not

In 2005, AIMA published its research on Asset

The body of the document

provides more detailed commentary on the

included a global survey of hedge fund

AIMA is supported by over 1,100 member

managers, investors and fund administrators.

companies in 47 countries. The creation of

The intention was to gain an understanding

its range of guides to sound practices and its

of perceptions and practices in this area:

many other initiatives would not have been

independent administrators, the range of

volunteers. For this publication it was also

instrument pricing sources, governance over

important for us to be able to draw on the

fund valuation and the various roles of those

experience of a meaningful cross-section of

involved in the pricing function. We issued

managers, investors, administrators and

20 practical Recommendations for sound

valuation practices within the industry.

sincere gratitude and appreciation to the

The study has been well received by the

We express our most

authors of this study, each of whom is named

in its most detailed analysis of the industry.2

This study has been designed for use by fund

The International Organisation of Securities

managers, investors and all those servicing

Commissions (IOSCO) is scheduled to release,

and providing professional advice to the

for public consultation, a paper on valuation

hedge fund industry. We believe that you will

principles for complex and illiquid financial

find the study practical and helpful and that

instruments in the second quarter of 2007.

AIMAs 15 Recommendations can be adopted

AIMA believes that the enhancement of sound

as sound practice across the industry.

practices in the area of valuation is an ongoing

We welcome your input on any of the items

process, given the evolution of different types

within; please contact info@aima.org.

of instruments and developments in valuation

Recommendations have been made to reflect

developments in the industry and to remove

AIMA Asset Pricing Committee

Drawing on feedback after its initial survey

The Valuation Service

of valuation issues in the industry, AIMA has

Provider will typically be the Funds

brought together a broad working party of

Administrator. The triangular relationship of

experts, representing all stakeholders in