Why Valuation Reports Are Not Audits or Due-Diligence Investigations
By Murray C. Grenville, CEO, Sterling Valuation Group
While hedge funds, private-equity funds, and other investment companies hire outside valuators like Sterling Valuation Group to provide a neutral third-party valuation of the funds’ illiquid assets, our reports are not audits or due-diligence investigations of the portfolio company.
Investment managers hire us to demonstrate to investors a strong internal-controls environment. We assist in the managers’ valuation process to support that the fund’s reported valuations, usually done each quarter, are market-based and consider all relevant factors using reliable methodologies resulting in reasonable estimates of fair market value. After all, the funds’ fees are based on investment performance. Additionally, in raising capital for new funds, investors will assess the historical performance of the manager’s current funds.
But we don’t identify or verify all matters that an audit, extensive examination, or due-diligence investigation might disclose. Instead, we rely on data from the funds to value these complicated assets, including real estate, mines, certain derivatives, leveraged loans, PIPE investments, and many others.
We do also use external data and our knowledge of these industries. In addition to our internal resources, we draw on a diverse team of professionals, including academic advisors and legal counsel with specific industry or product expertise.
Beyond certain well-founded facts, a valuation often has to proceed on the basis of assumptions. We develop a tailored methodology for each investment based on our experience with similar investments and our client’s valuation philosophy. We describe the methodology in detail in each report and outline how we’ve applied that methodology in the valuation of each investment.
We’ve built our reputation on the rigorous process through which we distill complex information, apply market insight, and bring our knowledge and industry experience to bear to our valuation process.
We like to keep our models simple. We use models that capture the complexities of the investment but aren’t more complicated than needed. A model should give rise to an understanding of an asset’s economics to price it appropriately. It should also be one that can be used and maintained with a reasonable amount of effort.
Our valuations are given as a range that involves complicated judgment calls. Valuation is an art, not a science. In our experience, the valuation range is up to 5 percent on either side of the mid-point value. In volatile times, that margin can be wider.