Valuing Alternative Investments Under ASC 820

Alternative investments became an increasingly popular investment class for endowment funds, retirement plans, and funds managed by not-for-profit organizations because they had low correlations with the rest of the market and were used to diversify large investment portfolios.  The 2008 financial crisis exposed many entities to investments that are now illiquid and hard to value, and yet they must still meet the rigorous requirements of fair value under ASC 820.

The issuance by FASB of ASC 820 (formerly FAS 157) created a new fair value standard for all asset classes including alternative investments.  Measuring the fair value of alternative investments for the purpose of meeting ASC 820 can be difficult and uncertain due to lack of liquidity and limited pricing transparency, both which pose significant oversight problems to fiduciaries and their auditors.

For information on how DerivActiv can assist with determining fair value of alternative investments to comply with ASC 820 call 1-866-200-9012.

Valuing Alternative Investments to Meet ASC 820 Requirements

A key objective of ASC 820 is increased transparency in financial reporting, which puts a rigorous fiduciary burden on managers of public and private investments.  Although a fiduciary can accept quarterly valuations from alternative investment managers such as private equity and hedge fund, independent studies have proven that fund managers have a bias of reporting inflated valuations of ongoing investments.  They are motivated to inflate valuations because their compensation is performance-based and they can get away with inflating valuations because alternative investments are opaque and thus values are difficult to substantiate.  Although it may be expedient to simply pass along the values from the hedge fund manager, best practices suggest that each reporting entity should produce its own fair value valuations or should get timely, accurate information from an independent source that has no financial interest in the valuation.  In order to adequately meet the new reporting and valuation requirements under ASC 820, the reporting entity must now demonstrate that a specific process is being followed in order to determine the fair value of an asset.  The AICPA has established guidelines for a process that fiduciaries should follow as best practices.

Description of Alternative Investments

Many market participants believe that alternative investments have a very narrow definition and do not include traditional asset classes.  In fact, alternative investments include traditional asset classes such as private equity (both common and preferred stock issued by private companies) and fixed income securities, as well as guaranteed investment contracts (GICs), collateralized mortgage obligations (CMOs), collateralized debt obligations (CDOs), some types of mortgage backed securities (MBSs), real estate funds, hedge fund investments, and private equity funds or fund of funds.  Unlike marketable securities, which trade over-the-counter or on an exchange where prices are readily available, alternative investments are generally illiquid and not traded.

Alternative Investment Portfolio Simulation

Since market prices for alternative investments are often unavailable, stale, or don’t reflect an actual transaction, it is quite challenging to value alternative investments under ASC 820.  In addition, hedge fund managers often provide limited information about asset values, which adds to the challenge.  DerivActiv can produce ASC 820 compliant valuations by performing a portfolio simulation process on alternative investments.  We use information provided by the asset managers such as asset type, geography, industry distribution, and leverage, etc., which enables us to create a “simulated” portfolio using publicly traded securities that have the same attributes. Using this process we are able to mimic the performance of the alternative investment portfolio and validate both the returns and fair value of the target portfolio. Our valuations can be relied upon by fiduciaries for all types of hard to value investments, including alternative investments, and our process has been approved by the auditing community.

For help with alternative investment valuations, call DerivActiv at 866-200-9012.