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FRM Part II · FRM Exam Part II · Performing Due Diligence on Specific Managers and Funds

An allocator is reviewing a hedge fund that holds a large position in thinly traded convertible bonds. During operational due diligence, which valuation practice would give the allocator the greatest comfort that month-end NAVs are reliable?

Independent administrator pricing using third-party sources, with overrides governed by a documented policy and a valuation committee, gives the most comfort. It separates valuation from the portfolio manager, whose fees depend on NAV, and limits the conflict of interest in illiquid positions.

  1. APricing is set by the portfolio manager who holds the best market knowledge of the positions
  2. BPricing is performed by an independent administrator using third-party sources, with a documented policy for overriding prices that is approved by a valuation committeeCorrect
  3. CPricing uses the broker quote that is highest among those received, to reflect the fund's skill
  4. DPricing relies on the prior month's value unless the manager believes a change exceeds 5%

Explanation

Independence of the pricing function from the portfolio manager, with documented and governed overrides, is the core valuation control. Letting the manager set prices creates a conflict because fees depend on NAV. Choosing the highest quote and stale pricing both bias values.

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