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FRM Part II · FRM Exam Part II · Private Markets Investing

During operational due diligence on a private credit fund, an allocator finds that the manager's valuation committee consists of the portfolio managers who source the loans, with no independent member, and the manager's fee is based on NAV. Which is the most appropriate conclusion?

The setup creates a valuation conflict, because people who source assets and earn fees tied to NAV also determine the values. The allocator should require independent valuation oversight or third-party pricing before committing capital.

  1. AValuation conflict of interest exists, so the allocator should seek independent valuation or oversight before committingCorrect
  2. BThe structure is best practice because portfolio managers know the assets best
  3. CThe risk is mitigated automatically because fees are based on NAV
  4. DThe issue is irrelevant if the fund reports positive returns

Explanation

When those who earn fees on NAV also set valuations, there is an incentive to overstate values. Best practice includes independent valuation functions or committee members and third-party pricing. Positive returns do not remove the conflict; they may be a symptom of it.

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