FRM Part II · FRM Exam Part II · Performing Due Diligence on Specific Managers and Funds
An investor allocates to a fund whose reported NAV relies on illiquid positions priced by the portfolio manager. The fund's administrator only records the manager's marks. In an operational due diligence review, which control change would most reduce valuation fraud risk?
An independent valuation committee, with third-party prices or models sourced by the administrator and manager marks open to challenge, best reduces valuation fraud risk. It separates the valuation function from the party who benefits from the marks, unlike attestations, reduced reporting frequency or co-investment.
- ARequire the portfolio manager to sign a representation letter each quarter attesting to the marks
- BMove to annual instead of monthly NAV reporting
- CEstablish an independent valuation committee, with the administrator sourcing third-party prices or models for illiquid positions, and with the manager's input subject to challengeCorrect
- DIncrease the manager's co-investment in the fund
Explanation
Valuation risk arises when the party benefiting from the marks controls them. Independent pricing and a committee with challenge authority separate duties. Attestations are not independent evidence, less frequent reporting reduces transparency rather than fraud risk, and co-investment only aligns incentives without creating verification.
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