Two Hedge Funds Report Assets Are Nearly Gone
Wall Street Journal journalists Kate Kelly, Serena Ng and Michael Hudson report that two once-large hedge funds are barely worth the paper that documents their existence. According to a letter to investors, parent Bear Stearns has already committed $1.6 billion in a "collateralized repo line to the High-Grade Fund" but cautions that prices are dropping fast. At the heart of the matter is the challenge to "place values on assets tied to subprime home loans" that are not actively bought and sold. (See "Subprime Uncertainty Fans Out - Bear's Hedge Funds Are Basically Worthless; More Bond Fire Sales," Wall Street Journal, July 18, 2007.)
As an accredited appraiser, I'm here to say that there is an entire industry of valuation professionals who eat, live and breathe process, standards and methodologies. In fact, following the U.S. savings and loan debacle in the early 1980's and the 1989 enactment of the Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA"), Congress essentially sanctioned the work of several entities - Appraiser Qualifications Board and the Appraisal Standards Board. For more information about the Appraisal Foundation and its history, click here.
So the hullabaloo about valuation problems (likely the tip of the iceberg) is extremely important but ignores a critical point.
In general (and not necessarily germane to this particular pair of hedge funds), a failure of institutional investors to oversee who renders value numbers, how, and on what basis, opens the door to "anything goes." Independent assessments of models and processes are arguably more important than ever before. If plan sponsors feel uncomfortable with the rigors of valuation and risk management, hire experts to help. Make sure that they know what they are doing. Ask whether they have specialized credentials and experience.
Why is valuation so important? Numbers drive nearly EVERYTHING financial, from performance reporting to risk management to determination of fees and asset allocation decisions. GIGO - Garbage in, garbage out - could be very hard to explain as an acceptable basis for good decision-making.
If you are interested in reading a June 4, 2007 interview I gave to Securities Industry News about hedge fund valuation, click here.
