Can a hedge fund value its own assets?

Hedge Fund Questions

For the new year we will publish a list of common questions we receive from our readers.  This question involves hedge fund valuation.

Question: Can a hedge fund provide its own valuation?

Answer: Generally yes, provided that the hedge fund offering documents state that the valuation of the hedge fund’s assets will be conducted by the fund – more specifically by the hedge fund’s management company.  In many hedge fund documents a provision which allows a manager flexibility in valuation is standard – although, it is likely that these normally nebulous provisions will become more specific as institutional investors require greater specificity in the offering documents.
For managers who wish to value their fund’s assets (or only certain assets), the best practice is for the manager to develop valuation guidelines with the hedge fund attorney.  By drawing up valuation guidelines (and following those guidelines), the manager will protect himself from potentially capricious valuations.

Whether such valuation policies are included in the offering documents is another question.  We have produced documents which do it both ways.  Some managers will also choose to inform investors that they have a valuation policy and that it is available under certain circumstances.  For the most part I think that most managers choose to keep the exact valuation methods out of the documents, but this is something that could change also if the industry moves toward greater disclosure requirements.

As some managers will not want to provide valuations because of liability concerns, there are alternative methods for making sure that any valuation is appropriate.  Two of the most common are: utilizing a third party for valuation and instituting a side-pocket mechanism.

Third Party Valuation

Many managers don’t want to use outside parties for valuing the assets of the fund as this can be costly (and potentially time consuming).  However, using an outside party for valuation should alleviate any liability concerns the manager may have if the manager valued the assets itself.

Side Pockets

Using a hedge fund side pocket account is a common way for managers to get around having to value their assets.  The side pocket structure is particularly effective in making sure that there is no overpayment or underpayment with regard to the performance fee because the performance fee is not paid until there has been a disposition of the asset.

Other

If the hedge fund has ERISA assets, there may be some issues under the ERISA rules which a manager should be aware of – the lawyer should discuss these issues with the manager.  Please contact us if you have additional questions on this article or if you would like help starting a hedge fund.  Other related hedge fund law articles include:

2 thoughts on “Can a hedge fund value its own assets?

  1. Pingback: Important Hedge Fund Articles — Hedge Fund Law Blog

Leave a Reply