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FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure

A hedge fund manager is deciding whether to appoint an independent third-party administrator to calculate the fund's NAV and handle investor subscriptions and redemptions, rather than doing so in-house. Which conflict of interest does the use of an independent administrator most directly mitigate?

An independent administrator mainly mitigates the manager's incentive to misvalue illiquid positions to inflate NAV and fees. Because fees depend on reported value, separating valuation and record-keeping from the portfolio manager provides an independent check and reduces the opportunity for manipulation.

  1. AThe manager's incentive to misvalue illiquid positions to inflate reported performance and feesCorrect
  2. BThe manager's incentive to hold concentrated positions in a single sector
  3. CThe prime broker's incentive to raise margin requirements during stress
  4. DThe investors' incentive to redeem simultaneously at quarter-end

Explanation

Performance fees and AUM-based fees depend on reported NAV, so a manager who controls valuation can be tempted to overstate marks on illiquid assets. An independent administrator separates valuation and record-keeping from the portfolio manager. The other options are not conflicts addressed by administration.

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