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

During due diligence on a long/short equity hedge fund, an allocator wants to verify how the fund's portfolio is valued each month. Which finding would be the strongest control and cause the least concern?

The strongest finding is independent administrator pricing of liquid positions from third-party sources, plus a documented valuation committee process for illiquid holdings with oversight beyond the portfolio manager. Valuation must be independent of the person whose fees depend on performance, so manager-controlled marks are a concern.

  1. AThe portfolio manager marks all positions and the administrator records those prices
  2. BAn independent administrator prices liquid positions from third-party sources, with a documented valuation committee policy for illiquid positions that includes non-portfolio-manager oversightCorrect
  3. CThe prime broker alone supplies marks without any reconciliation
  4. DThe CFO, who reports to the portfolio manager, overrides administrator prices when they are unfavourable

Explanation

Valuation independence from the portfolio manager is key because the manager's fees depend on performance. Independent pricing plus a governed process for illiquid assets is the best control. The other options allow manager influence or lack reconciliation.

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