Hidden risk: Investors skim over question of fund valuation

By Christine Williamson

With so much money rushing into hedge funds, people are very anxious about preserving capacity and that's when they begin to cut corners, when it becomes more of a seller's market. But it's the fiduciary responsibility of (institutional) investors to make sure that their fund-of-funds managers are asking all of the right questions about the process of due diligence and portfolio construction, including valuation. It's a bad assumption to think that all fund-of-funds companies are conducting the right level of analysis on the hedge funds they use,'' said Leslie Rahl, president and chief executive officer of Capital Market Risk Advisors LLC, New York, a hedge fund risk analysis firm and consultant.

There is enormous interest in this area, but there is still a lot of education to be done of both investors and managers,'' said CMRA's Ms. Rahl. ``There are a lot of nuances that people are not fully comprehending. Questions have to be very carefully tailored for each kind of strategy. Valuation is an issue any time you have an instrument that's not traded in a transparent, liquid market. Intelligent, well-meaning people will often price the same securities very differently.''

The Investor Risk Committee of the International Association of Financial Engineers, Washington, for example, released a white paper on hedge fund portfolio valuation recommendations in early June. Ms. Rahl has served on the IAFE committee that worked on the recommendations for the past two years and co-chaired it last year.

July 12, 2004