Friday, February 24, 2012

WSJ: Private-Equity Fund in Valuation Inquiry

By Tim Dulaney, PhD and Craig McCann, PhD, CFA

There is an article in the Wall Street Journal today concerning the alleged exaggeration of an asset's value in a private-equity fund.  From the article:
The potential exaggeration in the [Oppenheimer Global Resource Private Equity Fund LP] grew to more than $4 million, according to documents shared with Oppenheimer investors. The bulk of this markup came as the fund was reaching out to potential investors in the fall of 2009, and helped push the fund's reported internal rate of return to 38%, after fees, from a loss of 6.3%.
Following the alleged exaggeration, the fund raised more than $55 million from individuals, an academic institution and municipalities.  Such decision makers (perhaps non-profits and municipal issuers in particular) are vulnerable targets for abusive sales resulting from over-exaggerated asset valuation.

Hedge funds often hold illiquid or even obscure assets. For example, the asset under scrutiny in this case was an investment in a fund (Cartesian Investors A LP) with shares in a single asset: "a closed-end fund set up by the Romanian government to benefit citizens whose property was expropriated during Communist rule."  The lack of liquidity of the underlying investments allows the hedge funds to report inflated asset values and control the reported "appreciation".

This ability to value assets with great discretion generates smoothed returns superficially reflecting characteristics of low-risk investments (sometimes masking extraordinarily high risk investments).  Both FINRA and the SEC have written about the risks of hedge fund investing.  Since many hedge funds do not register with the SEC, investors are not protected by the relatively high exposure of registered securities.  As such, it is often difficult to independently verify information reported by hedge funds.

We'll be keeping an eye on this story as it develops.  

1 comment:

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