Alternative investment purchasers include endowment funds for hospitals and other non-profits, pension plans, and investment companies. Over the past couple of decades, it became much more commonplace to use alternative investments as a way to diversify large investment portfolios. As demand for alternative investments grew, the variety of hedge funds, private equity, and other types of alternative investments grew as well, providing even more diversity for investors. Alternative investments can range from a portfolio of traditional asset classes with marketable securities to a combination of complex and/or illiquid investments. Many alternative investments however, fall into the latter category where they are thinly traded or illiquid, with no available market prices. These alternative investments present a much greater challenge in obtaining sufficient auditable evidence for determining and substantiating fair market value due to the limited information generally provided by asset managers.
DerivActiv can validate returns on alternative investments for fair value measurement. For more information call 866-200-9012.
Best Practice Checklist for Alternative Investment Valuation
Initial Due Diligence
- Conduct face-to-face meetings with the investment firm’s management team
- Conduct on-site visit(s), including back office and operational due diligence
- Evaluate investment strategy, process and portfolio
- Review historical performance and attribution analysis (audited, if possible
- Review valuation procedures
- Request documents review by investment staff
- Offering memorandum
- Legal agreements
- Pitch books
- Information requests
- Financial statements
- Form ADV (used by advisers to register with SEC as investment advisers)
- Evaluate how the specific allocation fits within the asset class and the overall portfolio
- Solicit information regarding the team/firm from knowledgeable third parties
- Inform investment committee members that a manager is under consideration and request their input if they know the manager
- Consultants
- Competing investment managers
- Perform reference checks
- Other investors
- Investee companies
- Service providers
- Prior employers
- Perform third-party background checks on senior professionals
- Verify biographical information
- Perform criminal background search
- Perform press search
- Review and negotiate legal agreements
- Complete a formal investment memorandum/write up or other investment approval review
Ongoing Monitoring
- Conduct regular in person or telephonic meetings with the investment firm management team
- Conduct on-site visit, typically done on an annual basis (often substitute with attending annual meeting)
- Review fund communications
- Review fund communications including quarterly shareholder’s letters, etc.
- Obtain and review audited financial statements, note whether the opinion is qualified, any change in the auditor, change in valuation procedures
- For drawdown funds, compare partners’ capital statements with internal transaction records
- Review SAS 70 reports if available, and ensure that identified user controls are in place at the investor entity
- Perform valuation
- For custodial assets, reconcile with custodian’s pricing
- Request and review any changes to valuation policies and procedures
- For hedge funds, receive estimated value from fund and final value from fund administrator; compare for reasonableness
- Compare the institution’s statement of value received as of the fund’s year end to the value based on the fund’s audited financial statements and follow up on significant discrepancies
- Monitor portfolio performance
- Compare performance to benchmark and expected returns if appropriate
- Compare performance to publicly available data (for example, public sector indices for hedge funds)
- Compare cash returns to previously reported market values throughout the year
- Inquire periodically as to the total long and short positions throughout the year (for hedge funds)
- Review portfolio holdings on a regular basis
- If the investment strategy changes from the original investment approach, conduct comprehensive review of manager/team/strategy
- Monitor firm/manager
- Review press reports for significant management/structure/personnel/portfolio developments
- Obtain and review Form ADV
- Monitor staffing levels, personnel changes
- Monitor size of assets under management in the strategy and firm wide
- Verify portfolio returns through a portfolio simulation test
- Request portfolio holdings, strategies and leverage
- Build a new portfolio (the “simulated” portfolio) that mimics the actual portfolio characteristics
- Use the simulated portfolio to verify reasonableness of returns and calculate FMV
- Compare simulated portfolio’s NAV to the actual portfolio’s NAV
Call DerivActiv at 1-866-200-9012 to speak with an expert on how to start implementing these steps today.
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