Speakers at NumeriX-sponsored webinar sheds light on best practice for valuing portfolios
Today, it is common for two hedge funds with the same portfolio to come up with two very different portfolio valuation. The variance between these two portfolio valuations can be as great as 20 to 30%. Such a discrepancy should no longer be acceptable.
The industry needs to create an industry-wide standard pricing methodology for valuing portfolios today, said Sameer Shalaby, ceo Paladyne Systems speaking during the NumeriX Summer Webinar Series: Hedge Fund Portfolio Pricing Best Practices. Use of such a standard pricing policy would greatly reduce the variance in pricing existing today – a move which would benefit all market participants and not just hedge funds.
The after effects of the credit crunch – bank write-downs and hedge funds blowing up from pricing issues – indicate pricing is a real issue for market participants. And this is especially true for fund managers who are increasing investing in more complex and exotic instruments, which are notoriously difficult to value.
The President’s Working Group, a working group within the US Treasury Department, is reportedly looking to create recommendations for an industry standard for valuing portfolios. But if the industry can collectively create a set of standard pricing policies quickly, these guidelines can be used as a ‘roadmap’ for future regulatory requirements, said Shalaby.
Some of the larger hedge funds have already implemented internal pricing policies to maintain consistency and transparency in the short-term, but the small to medium sized funds have much more to do.
Many of the smaller sized funds still haven’t separated the pricing process in the front and back office. This means the front office submits a price and the back office will use this price without any validation or comparison with other data sources and modeling software. The back office needs to be ‘the arbitrator of the front office pricing" argues Shalaby. Also, fund management companies should refer to multiple sources of prices, such as fund administrators, data vendors or independent pricing software.
And the spreadsheets have to go. Fund managers still rely heavily on spread sheets but spread sheets are not a very ‘powerful tool to actually enforce any pricing standard within a fund’ because there is no way to audit sheets nor can you do data integrity checks on these sheets. And audit checks are a crucial part of maintaining any pricing methodology. Shalaby suggests a fund should really create an audit committee comprising of managers from the front office, back office and risk management team to regularly review pricing standards and conduct audits.
Fund managers should ideally implement pricing software in the front office, risk management department and back office so each department can use for their own purposes but also compare with other departments, said Kevin Samborn, cto of NumeriX. This provides the consistency and transparency crucial to the pricing process.
Also, when selecting software a firm should ensure the solution is flexible and can be used in different departments and for multiple purposes, said Samborn. And for fund management companies who rely on third parties for their pricing processing, they need to review how the provider is coming up with prices and what software they use.
*This article is based on the comments made during NumeriX Summer Webinar Series: Hedge Fund Portfolio Pricing Best Practices held June 25th. For more information this Webinar or future events hosted by the NumeriX, please refer to their web site at http://www.numerix.com/