Institutional Investor's Alpha Magazine - September 2008 - (Page 14)

True Value T he V word — valuation — keeps circling the hedge fund industry, rearing its head more and more often as everyone from investors to regulators asks whether managers are really offering accurate asset reports. One of the most notable incidents of late occurred in July, when the Boston ofﬁce of the U.S. Department of Labor announced an investigation into how corporate pension plan f iduciaries value alternative investments like hedge funds. The suggestion is that commonly used valuation practices may be in violation of ERISA, and the agency wants pension plans to require third-party valuations of assets rather than rely on managers to voluntarily come clean. The proposal could put the force of law into recommendations announced this spring by the President’s Working Group on Financial Markets, and it has some support. “For plan sponsors to get the numbers from the hedge fund is not doing due diligence,” says Susan Mangiero, president of Pension Governance, a research ﬁrm in Trumbull, Connecticut. “To remain prudent, you have to do your own homework.” Others believe legislating such practices may be going too far. Timothy Selby, a New York–based partner and head of the hedge fund practice at law ﬁrm Alston + Bird favors selfvaluation by hedge funds. “They, rather than regulators, understand the industry best,” he says. “I think the PWG approach is a terrific one and that it will ultimately carry the day.” (The PWG recommendations include guidelines that stress clear manager disclosures to potential investors and emphasize the due-diligence responsibilities of ﬁduciaries.) The Managed Funds Association, the Washington-based group that lobbies for the hedge fund industry, concurs, saying in a letter to the Department of Labor that the . . . Fair Value emember back in June when David Einhorn went af ter Lehman Brothers, t he bank whose sudden deflat ion stunned Wall Street this month? Now it’s the hedge fund industr y ’s turn to come under scrutiny. Einhorn, who manages Greenlight Capital, a $6 billion, New York– based hedge fund firm, zeroed in on how Lehman was valuing so-called Level III assets — illiquid and hard-to-value holdings like loans to troubled real estate developers, for instance. Under FAS 157, a new accounting rule that sets a fair-value David measurement standard, financial entities Einhorn must now separate their assets into three categories (from Level I, the most liquid and easiest to value, to Level III). The rule also requires firms to document how they calculate valuations. It’s no longer enough, in other words, to say something is worth what you paid for it and call it a day. FAS 157 doesn’t force write-downs, but it does enable investors to press for more details — as Einhorn did with Lehman. Unlike publicly traded institutions, however, most hedge funds will not have to produce financials under the new guidelines until after the end of this year. Michael Patanella, a New York–based partner with accounting firm Grant Thornton, believes that the sooner FAS 157 comes into play, the bet ter. “Given the environment we are in,” Patanella says, “I think investors want to know how these assets are being valued.” — I. R.-S. R DoL’sBoston office has “unreasonable and impractical expectations.” The MFA also asserts that the Boston proposal may do little more than rattle investors and “have an adverse effect on the ability of pension plans to invest in alternative investment vehicles, to the detriment of plans.” Regardless of whether valuation practices are eventually legislated, Brian Tsai, chief operating ofﬁcer for $1.3 billion New York–based hedge fund ﬁ rm Equinox Partners, thinks they should be reliable — now and in the future. “Firms need to have operations to tackle pricing, fair value, consistency in protocol and trade settlement, as well as portfolios of illiquid assets,” he says. Complicating the question of whether and when the government gets involved is the issue of which agency would do the enforcing. “People are questioning whether the Department of Labor can be effective,” says Karl D’Cunha, Chicago-based co-head of the hedge fund advisory services group at business-valuation f irm Houlihan Smith & Co. He notes that valuation wasn’t such a hot issue with investors or regulators when hedge funds were logging better returns than most of them are now. “Robust valuation wasn’t on their checklist — now it is.” — Janice Fioravante A Chill in the Air in Brazil L atin America–based hedge funds aren’t the irresistible lure they were just a few months ago. Some have seen drawdowns of as much as 40 percent as commodities prices have reversed the past year’s sharp climbs. Broader risk aversion among investors who have the subprime jitters only adds to skepticism regarding a region that doesn’t exactly have a history of economic stability. Photo by Eric McNatt for Alpha 14 • INSTITUTIONAL INVESTOR’S ALPHA • SEPTEMBER 2008

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - September 2008

Institutional Investor's Alpha Magazine - September 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Culling the Herd The Good Guys: Ending the Cycle Interview: Press Credentials Cover Story: Rethinking Chris Hohn Strategies: At the Edge of the Earth Profile: Alpha Femals Strategies: Tails, You Lose Research Center: The Top Equity Trading Firms Alpha Bytes: The Light Is On Unhedged: Commentary: Not-So-Dire Diagnosis

Institutional Investor's Alpha Magazine - September 2008

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