Valuation Guidelines for Alternative Asset Managers: Best Practices and In-House vs. External

Alternative investment managers face many issues regarding the valuations of their portfolio investments. Hence, there are a handful of considerations they should consider to ensure seamless valuations. Part I of the two-part article series will discuss some of these best valuation practices along with conducting valuations in-house versus partnering with an external provider. Part II will address how the SEC’s Private Fund Adviser Rule has impacted portfolio valuations.  

These valuation considerations were a topic of concertation at the American Society of Appraisers (“ASA”) recent Fair Value Conference (“FV Conference”) in New York City, which was sponsored by EisnerAmper and Empire Valuation Consultants where Craig Ter Boss, Partner, EisnerAmper’s Corporate Finance Group, share his insights on these topics. 

Best Practices  

The following are a handful of best practices valuation committees should establish when it comes to their policies and procedures: 

• Establish effective valuation policies and specific and detailed procedures, including a methodology for estimating the fair value of Level 3 assets (for which no significant observable inputs are available).  
• Create a valuation committee and define roles for the personnel responsible for implementing and maintaining the valuation policies and procedures.
• Evaluate whether the policies and procedures are applied consistently and document any divergence from them (e.g., customizing valuation policies with the valuation process and the methods used to reduce any potential conflicts of interest).
• Evaluating whether the policies and procedures for portfolio investment valuations are robust, transparent, and flexible.  

Additionally, the following are several best practices for conducting the actual valuations.  

• Use multiple valuation approaches when appropriate and explain the rationale for weighting the approaches. If a strategy is not utilized, explain the exclusion of that approach.  
• Document and explain the selection of crucial valuation assumptions (observable and unobservable), including how such assumptions are determined and changes in such assumptions and make inputs into the model transparent.  
• Providing a risk assessment update that considers macroeconomic, industry, and company-specific factors that may impact the value of the investment.  
• Link the current valuation to the investment thesis and provide key factors monitored for the investment since inception.
• Utilizing independent, third-party valuation support for the fund’s most significant Level 3 assets at least annually. These external valuation specialists can help funds mitigate valuation risk and facilitate a more efficient audit process. 

In-House Valuations Versus External Valuations  

Numerous factors must be considered when determining whether to perform portfolio valuations in-house or outsource to an external provider.    

• Perception 
  Funds that perform their valuations in-house are open to more skepticism from current and potential investors.
• Internal Resources 
  One key requirement for an in-house valuation team is ensuring that the valuation is carried out by a team that is independent of the deal or the investment team while having the support of those teams to obtain relevant information to perform valuations.
• Audit Process 
  The audit process is a lengthy process with a significant focus on the valuation of the investments and whether the valuation policies and procedures were completed in compliance with such policies. This process also puts a considerable strain on internal resources. In this regard, third-party valuation service advisors can help fund managers with additional insight into state-of-the-art valuation techniques, improve the efficiency of the audit process, and provide in-depth market intelligence. 

Overall, there has been a movement in recent years toward the use of external valuation firms, considering the increased auditor scrutiny and the need to reduce the appearance of bias in determining fair values for Level 3 investments. Stay tuned for Part II on how the SEC Private Fund Adviser Rules impact valuations.