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Digital Subscriptions > The Hedge Fund Journal > Issue 129 – January 2018 > Houlihan Lokey’s Valuation Practice

Houlihan Lokey’s Valuation Practice

Independent valuation analysis for Level 2 and Level 3 assets

Houlihan Lokey’s Portfolio Valuation and Fund Advisory Services practice carries out valuation analysis of assets held by hedge funds, private equity funds, BDCs, and other investment advisors such as venture capital funds, mutual funds and real estate funds.

Drivers of growth

Multiple drivers encourage, and sometimes compel, greater use of independent, third party valuation agents. Regulatory enforcement actions have highlighted a number of public cases, identifying issues with valuations of assets and/or sub-optimal valuation practices. Houlihan Lokey’s valuations have not been the subject of SEC enforcement actions, according to Ma.

The standard-setting body, the Standards Board for Alternative Investments (SBAI), (formerly called the Hedge Fund Standards Board (HFSB)), recommends the use of ‘an independent and competent thirdparty valuation service provider’. Whether or not they are SBAI signatories, institutional investors may require, or prefer, a valuation agent – at least for Level 3 assets (and increasingly for Level 2 assets as well) to avoid the perception of possible conflicts of interest where hedge fund managers, who are remunerated on the value of their fund assets, have the final say on valuation. Charging fees only upon realisation of illiquid assets does mitigate one potential conflict of interest, but it is usually only carried interest, or performance fees, that are disbursed in this way, while management fees also may be paid out based on unrealised valuations. Additionally, the possibility of using what may prove to be an inflated performance track record in order to raise assets can also be a contentious issue for regulators.

Secondary market activity in private equity interests, co-investments, side pockets, and sidecars can also prompt the need for a fresh valuation or a second opinion from valuation agents. This can be seen in the context of a general trend towards more transparency being provided to investors in multiple areas.

Regulations like Dodd-Frank and AIFMD can also encourage firms to seek independent valuation advice. For instance, a by-product of the risk retention rules for structured credit is that valuation agents need to confirm if structures meet the rules (eg for horizontal, vertical, and L-shaped risk retention in the US).

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