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Dealing with pricing anomalies for Illiquid OTC and private assets

Due to the fact that hedge funds deal in both liquid or illiquid assets, a number of added nuances and complexities tend to have an impact on the pricing process. Prices of liquid instruments are readily available and less disputable, which is why those that deal in liquid instruments, such as long-short, global macro and activist funds, have a more straightforward pricing process. For funds that deal in illiquid assets, such as swaps, ABS, MBS, bank debt, loans and private deals, the pricing process is a much more involved exercise for each of the following reasons:

Pricing Frequency:

Virtually all hedge funds publish a monthly NAV for investors, so pricing the portfolio monthly is a common, industry-wide expectation. More liquid instruments may be priced daily to capture day-to-day exposures, risks and P&L, but this process is much less stringent.

Time Pressure:

Monthly pricing kicks off on the last business day of the month. All open positions are obtained from the portfolio management or accounting system, and price quotes are obtained from a variety of different sources. The pricing team’s goal is to price most securities within a reasonable time frame and present the results to the valuation committee. This committee meets three to six business days after the end of the month. After the committee approves the prices, they are posted to the accounting system or the fund administrator in order to calculate the monthly NAV. However, many new fund structures require weekly liquidity and some credit funds even require daily liquidity, which means this process will almost certainly need to be automated.

Diverse Sources:

To price liquid or standardized instruments, hedge funds rely on market data providers that all tend to specialize in specific asset types. To price OTC or illiquid instruments, hedge funds use specialized pricing vendors and broker quotes. Some funds supplement broker quotes with internal valuation tools ranging from basic spreadsheets to complicated statistical models, whereas others rely on fund administrators. Funds can also turn to external valuation specialists or marking agents to price private deals.

Frequent Challenges:

Price challenges, which are when the pricing team reaches out to the vendor or broker to explain their rationale for contesting a price, happen constantly. A typical hedge fund will challenge between 10% and 30% of quotes in any given month. Tracking challenges and updating prices with revised quotes is a significant burden on the pricing team due to the fact that the process is manual, making it difficult to keep a clean audit of revised prices.

Multiple Reports:

At the end of the pricing cycle, the pricing team produces a valuation committee report, or a “pricing committee package.” This report lists all the positions in the portfolio, month-end prices, sources for each price and notes on any significant movement. Once finalized, the valuation committee approves this report, but the pricing team may also need to produce a series of other custom reports for audit, compliance, accounting and front-office needs. Since these reports are produced manually and must meet the same standard of accuracy as the committee report, the process is both error-prone and time consuming.

Approval & Posting:

As prices are finalized, the pricing team posts them to the accounting system, either internally or with the fund administrator. Some teams do this manually while others use automatic Excel macros. By posting the prices, it makes them available to other downstream processes, such as P&L reporting and reconciliation. However, the final prices can’t be locked and posted until the valuation committee approves them. At that point, reconciliation occurs, the pricing cycle comes to an end and the NAV calculation can be considered complete.

Many of the leading hedge funds dealing with illiquid and private assets use IVP’s Pricing and Valuation Automation Solution. Enabling funds to operationalize and automate their complex valuation policies in the most transparent manner, IVP’s Pricing and Valuation Automation Solution helps increase the auditability of the pricing process and investor confidence significantly.

For more information on how IVP’s Pricing and Valuation Automation Solution can help ensure a smoother pricing process, please email

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