Portfolio valuation
Valuation governance
Valuation governance
Your valuation process is only as good as the governance around it. Without proper controls, marks drift toward whatever makes the portfolio manager look good. This page covers the governance framework, independence requirements, committee structure, and when to bring in third parties.
Valuation policy
Every fund needs a written valuation policy approved by the board or GP. This policy is the foundation of your governance framework.
What the policy should cover
| Element | What to Include |
|---|---|
| Scope | Which positions, which fund vehicles, any exclusions |
| Frequency | Monthly, quarterly, or other; cut-off dates |
| Methodology | How fair value is determined by position type |
| Hierarchy | How you classify positions as Level 1, 2, or 3 |
| Independence | Who performs valuations, who reviews, who approves |
| Third-party use | When you engage external valuation agents |
| Escalation | How to handle disputes or material uncertainties |
| Documentation | What gets recorded, where, retention period |
Policy approval and review
The policy should be:
- Approved by the fund’s board, GP, or investment committee
- Not solely approved by the investment team (who have conflicts)
- Reviewed annually for adequacy
- Updated when new asset types are added to the portfolio
Consistency requirements
Once you establish a methodology for a position type, apply it consistently. Changing methodology quarter-to-quarter to achieve desired marks is a red flag for auditors and LPs.
If you need to change methodology, document:
- Why the prior methodology is no longer appropriate
- What changed (market conditions, position characteristics, better data availability)
- The impact of the change on the current mark
- That the change is prospective, not retroactive cherry-picking
Independence requirements
The person marking the portfolio should not be the same person who invested in it. Portfolio managers have inherent bias toward marks that make their investments look good. Independence is the primary control against that bias.
Typical structure for larger funds
| Function | Responsibility |
|---|---|
| Investment team | Provides inputs (deal data, performance updates, market color) |
| Valuation function | Applies methodology, proposes marks |
| Valuation committee | Reviews and approves marks |
| Auditors | Test methodology and marks |
The valuation function should report outside the investment team, typically to the CFO, COO, or an independent function.
Structure for smaller funds
If you are a small fund without a dedicated valuation team, you still need independence:
| Approach | How It Works |
|---|---|
| Third-party valuation agent | External firm marks material Level 3 positions |
| CFO or controller review | Non-investment professional reviews and approves marks |
| Independent board member | Board member with finance background reviews marks |
| Methodology lock | Methodology set at acquisition; PM cannot change assumptions |
The key is that someone outside the investment function has meaningful oversight of the marks.
Common independence failures
| Failure | Risk |
|---|---|
| PM proposes and approves marks | No check on optimistic assumptions |
| Valuation team reports to CIO | Independence is compromised |
| Third party “validates” but fund sets marks | Third party provides cover, not independence |
| No documentation of challenge | Oversight is ceremonial, not substantive |
Valuation committee
The valuation committee provides governance oversight of the marking process. It is not operational (it does not run the models) but it reviews, challenges, and approves.
Composition
| Role | Why Included |
|---|---|
| CFO or COO (chair) | Independent of investment, owns the process |
| Controller | Understands the accounting and documentation |
| Head of risk or compliance | Represents control function |
| Independent member (for larger funds) | External perspective |
The CIO or portfolio managers should not chair the committee. They may attend to answer questions, but the approval authority should rest with independent members.
Meeting frequency
| Fund Type | Typical Frequency |
|---|---|
| Monthly NAV fund | Monthly |
| Quarterly NAV fund | Quarterly |
| Funds with material changes | Ad hoc meetings as needed |
Meetings should be timed to align with NAV publication. The committee should review marks before they are finalized, not after.
Committee agenda
| Agenda Item | Purpose |
|---|---|
| Material marks and mark changes | Review positions with significant value or significant change |
| New positions | Establish methodology for newly acquired positions |
| Disputed marks | Resolve disagreements between investment and valuation teams |
| Third-party reports | Review independent valuation agent reports |
| Assumption changes | Approve changes to default, prepayment, or discount rate assumptions |
| Level 3 disclosure | Review sensitivity analysis and other required disclosures |
Documentation
Committee meetings should be documented with:
- Attendance
- Positions reviewed
- Key discussions
- Decisions made
- Any dissenting views
- Action items
This documentation becomes part of the audit trail.
Challenge process
Investment professionals should have a formal process to challenge marks they believe are incorrect. This is healthy. It brings information into the valuation process.
How the process should work
| Step | Description |
|---|---|
| Written submission | PM submits challenge in writing with supporting analysis |
| Committee review | Valuation committee reviews, not unilateral decision |
| Discussion | PM may present case; valuation team presents counter-view |
| Documented decision | Committee decides, documents rationale |
| Audit trail | Challenge and decision become part of position documentation |
What a good challenge looks like
A good challenge provides new information:
- Market data the valuation team did not have
- Performance trends that change assumptions
- Structural features that were not properly modeled
- Comparable transactions that suggest different value
What a bad challenge looks like
A bad challenge is just advocacy:
- “This mark makes my deal look bad”
- “I know this is worth more”
- “We paid more than this six months ago”
The committee should reject challenges that do not provide substantive new information.
Documentation requirements
Documentation is the audit trail that proves your marks are defensible. Without it, you have marks but no support.
Position-level documentation
For every position, maintain:
| Document | Content |
|---|---|
| Current and prior marks | Mark at this period and last period |
| Methodology | How you valued it (DCF, comps, dealer quotes, pricing service) |
| Key assumptions | Discount rate, prepayment, default, severity |
| Market data | Source and date of any market inputs |
| Adjustments | Any adjustments to raw data and rationale |
| Sensitivity analysis | For Level 3, how mark changes with assumptions |
| Approval | Who reviewed, who approved, when |
Portfolio-level documentation
| Document | Content |
|---|---|
| Valuation policy | Current approved policy |
| Committee minutes | Documentation of committee meetings |
| Third-party reports | Reports from valuation agents |
| Level classification summary | Positions by hierarchy level |
| Change log | Changes in methodology or assumptions |
Retention
Retain documentation for:
- Life of the fund plus statute of limitations for audit (typically 7 years)
- Or as specified in your LP agreement (some require longer)
Third-party valuation providers
Third-party valuation agents provide independent marks or methodology review. They are increasingly expected by institutional LPs.
When to use one
Consider engaging a third-party valuation agent when:
| Situation | Why Third Party Helps |
|---|---|
| Auditors request independent verification | Satisfies audit requirement |
| Institutional LPs request independent marks | Meets LP due diligence standard |
| Conflicts of interest | Co-invest with GP, related-party transactions |
| Material Level 3 positions | Adds credibility to marks |
| Asset class outside core expertise | Brings specialized knowledge |
What they provide
| Service | Description |
|---|---|
| Independent marks | Third-party opinion of fair value for reporting |
| Methodology review | Assessment of whether your valuation approach is reasonable |
| Assumption validation | Testing whether your inputs are supportable |
| Comfort letter | Written confirmation for audit |
Selecting a provider
| Criterion | What to Evaluate |
|---|---|
| Asset class expertise | Do they have experience with your specific collateral types? |
| Methodology transparency | Can they explain how they arrived at the mark? |
| Turnaround time | Can they meet your reporting deadlines? |
| Cost | Fee relative to positions being valued |
| Credentials | Recognized by auditors and institutional LPs |
Cost ranges
| Portfolio Size | Complexity | Annual Fee Range |
|---|---|---|
| Under $100M AUM | Moderate | $15K-$30K |
| $100M-$500M AUM | Moderate | $30K-$75K |
| $100M-$500M AUM | High (esoteric) | $75K-$150K |
| Over $500M AUM | Moderate | $75K-$150K |
| Over $500M AUM | High | $150K-$300K+ |
Illustrative pricing. See pricing disclaimer.
Fees vary by number of positions, asset class complexity, and frequency of valuation.
Major providers
- Kroll (formerly Duff and Phelps): Large platform, broad asset class coverage
- Houlihan Lokey: Strong in structured products and illiquid credit
- Lincoln International: Mid-market focus, private credit expertise
- Murray Devine: Boutique, specialized in structured finance
- Valuation Research Corporation (VRC): Broad coverage, competitive pricing
Working with third parties effectively
| Practice | Why It Matters |
|---|---|
| Provide complete deal documentation | They cannot value what they do not understand |
| Share your internal marks | Helps them understand your perspective (they may disagree) |
| Understand their methodology | You are responsible for the marks, even if third party provides them |
| Challenge when appropriate | Do not blindly accept marks you know are wrong |
| Plan ahead | They need time; last-minute requests cost more and may miss deadlines |
Audit considerations
Auditors test your valuation process as part of the annual audit. Understanding what they look for helps you prepare.
What auditors test
| Area | What They Examine |
|---|---|
| Policy compliance | Are you following your written policy? |
| Methodology consistency | Is the same methodology applied to similar positions? |
| Assumption reasonableness | Are inputs supportable based on market and historical data? |
| Independence | Is there separation between investment and valuation? |
| Documentation | Is there adequate support for the marks? |
| Third-party use | Were independent valuations obtained where appropriate? |
| Level classification | Are positions classified correctly in the hierarchy? |
Common findings
| Finding | How to Avoid |
|---|---|
| Insufficient documentation | Document as you go, not at audit time |
| Stale inputs | Refresh market data and assumptions each period |
| Methodology inconsistency | Establish approach at acquisition, apply consistently |
| Independence gaps | Ensure valuation function reports outside investment |
| Aggressive assumptions | Benchmark to market data, stress test assumptions |
Qualified opinions and material weaknesses
A qualified opinion on valuation or a material weakness finding creates significant problems:
- LP confidence erodes
- Regulatory scrutiny increases
- Future fundraising becomes harder
- Secondary market buyers discount your reported values
Invest in governance upfront to avoid these outcomes.