Global Hedge Fund
Valuation and Risk Management Survey
Insights into current industry practices*
ii SUMMARY RESULTS Global Hedge Fund Valuation and Risk Management Survey PricewaterhouseCoopers
As hedge funds continue to become more institutionalized, managers are facing
significant challenges on a variety of fronts, including rapid growth of assets,
greater regulatory scrutiny, and increased demands from investors. In this
environment, forward-thinking hedge fund managers are bolstering their controls
around valuation and building infrastructure to support risk management. At
the same time, managers must be cognizant to implement these changes in
ways that not only safeguard their firm’s reputation but also maintain operational
efficiency. Thus, firms are adopting different strategies in tailoring their risk
management programs to achieve a good balance between fostering growth and
ensuring proper control over investment and operational risks.
During September and October of 2004, PricewaterhouseCoopers conducted
its second hedge fund survey focused on valuation and risk management
issues impacting hedge fund managers. We posed questions that covered
broad risk-related topics, including governance, valuation, investment practices
and operational risk management practices. The survey questionnaire was
designed to gather detailed information on specific policies, procedures,
reporting, tools and organizational structures used by leading hedge fund firms.
The findings provide insights into current industry practices and innovations as
well as data to enable participants to benchmark their own initiatives to improve
controls and operational efficiency.
On the following pages, we provide a high-level summary of the survey data
and some trends in near-term risk management priorities for hedge fund
managers based on the survey results.
Highlights and Conclusions
✦ Enhanced risk management practices are clearly a priority for hedge fund managers. In particular,
all firms surveyed indicated that they dedicate significant time and resources to valuation issues.
However, despite increased expectations from regulators and investors, there are still large
differences in the transparency and documentation of valuation policies and procedures, especially
for non-listed and less liquid products.
✦ Survey participants also confirmed the importance of maintaining strong controls over valuation,
reconciliations and market risk. However, the data reveals a wide range in the size and
organization of resources used to support these functions and to maintain segregation of duties.
✦ Similarly, the firms in the survey population are at different stages in developing their basic risk
infrastructure consisting of compliance, internal audit, risk management and IT/data management.
✦ The survey confirmed that the governance structures of hedge funds have not changed
significantly despite the forces of change that have impacted public companies and registered
Profile of Survey Participants
68 firms based in the U.S., Europe, Asia, and Canada participated in the survey.
✦ The participating firms reported total assets under management in excess of $225 billion.
✦ The size of each firm’s assets under management ranged from $50 million to over $10 billion.
✦ 88% of the participants are stand-alone management firms; the remaining are part of larger
✦ The majority of survey participants are registered as investment advisors; 28% are registered as
commodity pool operators.
✦ Most firms describe themselves as multi-strategy with an average of 4.5 investment strategies
employed per firm. Sixteen firms described themselves as single strategy.
✦ The number of employees per firm ranged from less than 10 to more than 500, with an average
number of 9 serving as portfolio managers.
Risk Management Priorities and Oversight
Given the widespread discussion about the risk management “function” in the hedge fund industry and the role of the
independent risk manager, we asked participants to evaluate their risk management priorities and how they align their
professional staff to meet those objectives. The objectives at the top of the priority list were not surprising:
✦ Control the volatility of returns within each strategy;
✦ Manage and mitigate operational risks (transaction processing);
✦ Enforce strict compliance (regulatory reporting and personal trading); and
✦ Provide oversight for the valuation process.
Unlike larger, more diversified financial institutions, the survey confirmed that certain risk management practices,
including counterparty risk measurement and formalized approval of new instruments, appear to be lower priorities for
hedge fund managers.
2 SUMMARY RESULTS Global Hedge Fund Valuation and Risk Management Survey PricewaterhouseCoopers
There was a complete absence of consensus regarding the accountability for risk management (see Figure 1).
We received eight different responses to the question, “Who has the primary responsibility for risk management
in our organization?”.
The only option not selected was
the General Counsel. There was
Primary Responsibility for Risk Management
also a profound split regarding the
presence of a risk management No single Individual
16% General Partner(s)
committee – yes (31%), thinking 24%
about it (30%), and not considering
it (39%), which demonstrates the Senior Portfolio
Manager(s) Board of
diversity of views and approaches to 16% Directors
risk management. 3%
Given this fragmented picture
regarding the risk management Chief 17%
function, it was not surprising that 5%
the independent risk manager was Financial Officer Operating Officer
cited only occasionally in the survey 13% 6%
results. Approximately a third (31%)
of respondents currently have an
independent risk manager and more than half (52%) state that they have no plans to create the position in the near-
term. We found that the presence of a risk manager was more correlated to the size of the firm than to the mix of
investment strategies. For example, firms with assets under management exceeding $5 billion were more likely to
have a risk manager. Lastly, backgrounds of the existing risk managers varied, although a clear majority have trading
and/or quantitative experience.
Valuation Policies and Procedures
The survey results confirmed a broad range of practices employed by the participants in the valuation of positions
and independent price verification. However, despite the looming regulatory impact, only about half of the group
(56%) said that they maintain “detailed” valuation procedures. A much smaller proportion (37%) indicated that they
have instituted a formalized pricing committee and nearly half have no plans to establish one (48%).
On the topic of valuation practices, we made a careful distinction in the survey questions between determining,
reviewing and approving fair values (at the portfolio level as well as at the asset class level). We asked respondents to
identify specific individuals/departments with primary responsibility for each phase of the valuation process (Figure 2).
PricewaterhouseCoopers Global Hedge Fund Valuation and Risk Management Survey SUMMARY RESULTS 3
Third party administrators were frequently cited for determining portfolio fair values; whereas, the back office is primarily
responsible for reviewing and approving fair values. Nonetheless, we still found that the front office ultimately approves
the valuations in 20% of the firms surveyed. Other responses included the general partner, the board of directors and
the prime broker.
A substantial section of the
Segregation of Fair Value Responsibilities
survey probed procedures for
Front Office 17% 18% 20%
Determining obtaining and validating market
prices and other input values. We
Middle Office/ 10% 20% 10% Approving
Risk Management asked participants to complete
Back Office 20% 39% 31%
a matrix consisting of 19
product types across securities,
35% 12% 12% loans, structured products and
Pricing Committee/ derivatives, and assumed that the
Group 8% 7% 13%
three predominant sources were
2%, 2%, 2% pricing services, prime brokers
and quotations provided by other
Other 8% 2%12%
brokers/counterparties. The pattern
of “primary” and “secondary”
sources per product type contained
few surprises. However, especially
for less liquid products, the data revealed variations in the use of last trade, bid or mid-market quotes.
We posed several additional questions on definitions and procedures for pricing less liquid positions since the risks
of valuation subjectivity or disputes are more pronounced. The results present an overall impression of diligence,
although a third of the respondents stated that the process does not identify stale prices and more than half stated
that they do not perform “acid” testing to compare a recent transaction price to the prior valuation price. In addition,
in cases where dealers are an important source of price quotes, more than half (54%) stated that they do not
distinguish between dealers who are trading counterparties and those with whom they do not trade.
Organization for Independent Controls and Risk Management
A top-level review of the survey
data across all the categories of
Self-Assessment of Fund Performance in Key Risk Areas governance, organization, risk
management, valuation, controls
Risk technology 11% 41% 33% 3% Quite weak
People deployment Neither/Nor
and IT is remarkably consistent
for risk management, 25% 45% 16% 2% with the self-assessment distilled in
including price verification
Capital allocation 25% 45% 16% 2%
Very Strong Figure 3. For example, virtually all
survey participants responded that
Risk Aggregation 20% 42% 23%
they take care to devote sufficient
Controls 42% 44% 5% human and technical resources
Valuation 64% 20% 6%
to the fundamental controls over
valuation and key reconciliations.
Risk Management 28% 52% 11%
However, the self-assessment on
Risk Identification 34% 48% 6% methodologies and tools for risk
0 20 40 60 80 100 measurement and capital allocation
is less positive.
4 SUMMARY RESULTS Global Hedge Fund Valuation and Risk Management Survey PricewaterhouseCoopers
We then divided the survey population into three groups based on assets under management, and the organizational
profiles appeared in more stable patterns (Figure 4).
In addition to the roles outlined in
Figure 4, we found that the internal
audit function was not prevalent and Position Established Very Large Large Medium All
was generally found only at the hedge >$5 bn $5bn<>$1bn <$1bn %
funds sponsored by large financial Compliance Ofﬁcer 83% 71% 44% 65%
services companies and certain of In-house Counsel 78 56 22 49
the largest independent hedge fund Independent 37 44 12 31
managers. Risk Manager
Head of IT 45 41 32 40
Operational Risk Source: PricewaterhouseCoopers
In our survey, operational risk management refers to the controls and back-up facilities necessary to ensure
accurate, efficient transaction processing, reconciliations and document management. Virtually all respondents stated
that reconciliation processes are rigorous and documented, although the nature and extent of this documentation
varies significantly. Some of these processes are automated, although the degree of automation varies. The survey
results indicated that disaster recovery procedures have been formalized and tested at 53% of the respondents’ firms,
which is much lower than we would have expected.
About 70% of respondents outsource some or all of their back/middle-office functions to an independent third
party fund administrator or custodian (among large firms, this percentage drops to 59%). However, we noted that
more than two-thirds of respondents reported that their prime brokers/custodians and third party administrators
do not have a SAS 70 report or that they were unaware of the existence of a SAS 70 report. As the industry
continues to become more institutionalized, we believe that SAS 70’s reports may become more prevalent, and
we have already seen indications of this trend. While 80% of respondents stated that they monitored the same
back/middle office functions performed by these third parties, this suggests that 20% of respondents are not
mitigating the risk of error due to outsourced functions.
Disclosure to Regulators and Investors
Given the frequent discussion in the industry regarding investor and/or regulator demands for increased “transparency”
from hedge fund managers, we asked participants for their assessment of the current environment on reporting and
disclosure. Among the questions we asked were the following:
PricewaterhouseCoopers Global Hedge Fund Valuation and Risk Management Survey SUMMARY RESULTS 5
Regulators comprise an important
stakeholder group for hedge fund
Do you feel increasing pressure to have independent valuations performed managers and are very focused on
more frequently? valuation issues, as are investors.
However, the results indicated that
Yes 22% No 78%
few participants expect pressure
FIGURE 6 for more frequent independent
Do you feel increasing pressure from your investors to disclose valuations.
We also asked several questions
Yes 52% No 48% at a detailed level regarding
Source: PricewaterhouseCoopers current methods and format for
performance analysis, both for in-
house use and investor reporting. The data varied according to the primary strategies of the manager, although it is
noteworthy that over half of the respondents (54%) perform this analysis on an in-house application. In addition, risk
measures do not appear to be fully integrated into the assessment of portfolio manager performance; only half (50%)
of portfolio managers are measured on a risk-adjusted basis.
What Are the Priorities Going Forward?
At the conclusion of the survey, we asked each participant to tell us their “biggest” priority for next year. For the most
part, responses came in four categories:
✦ Improve returns on both an absolute and risk-adjusted basis;
✦ Expand product range and investment strategies;
✦ Improve controls and compliance procedures; and
✦ Strengthen back office and increase automation.
The hedge fund universe continues to be one of the most dynamic sectors in the financial services industry. At the
same time, as hedge funds continue to become more institutionalized, hedge fund managers will need to adapt to
new requirements emanating from investors, regulators and tax authorities.
Our survey data suggests that more firms are implementing robust tools and processes to manage operational
risks and minimize errors in valuation in light of these forces of change. However, managers are implementing these
controls in a variety of ways. We believe that there is no single right way to implement systems for valuation and risk
management, and we are committed to monitoring the continual developments in this industry. The degree to which
there will be a more standardized approach to risk management as the hedge fund industry matures remains unclear.
Also, given the institutionalization and regulatory scrutiny facing the industry, the question remains as to whether
hedge fund firms, which are individualistic by their nature, will continue to take diverse approaches based upon
philosophical differences and the unique nature of investment strategies.
Overview of PricewaterhouseCoopers’ Hedge Fund Practice
As a recognized leader serving both traditional and alternative investment management strategies,
PricewaterhouseCoopers is committed to helping our clients determine what successful firms will need to do in
order to stay at the forefront in an increasingly competitive and dynamic industry.
We are setting the pace in providing “best practice” and benchmarking information to the leaders in the private
investment funds industry through our seminars, special studies, and thought leadership initiatives. ✦
6 SUMMARY RESULTS Global Hedge Fund Valuation and Risk Management Survey PricewaterhouseCoopers
Survey Advisory Committee
Mark Casella Greg Eckert
New York San Francisco
1 646 471 2500 1 415 498 7443
Eric Gronningsater Graham Phillips
New York London
1 646 471 5493 44 20 7213 1719
Kevin Barry Marie-Anne Kong Yao Fah
New York Hong Kong
1 646 471 4711 85 2 2289 2707
PricewaterhouseCoopers Global Hedge Fund Valuation and Risk Management Survey SUMMARY RESULTS 7