Management’s Role in Valuing Alternative Investments with NAV’s

Management’s Role in Valuing Alternative Investments with NAV’s April 19, 2011

Presenter Today’s presenters: Paul Anderson Director of Assurance Services GBQ Partners LLC panderson@gbq.com 614.947.5203Jeff Alton Manager – Assurance Services GBQ Partners, LLC jalton@gbq.com 614.947-5202

Objectives • What are alternative investments with NAV? • How are alternative investments valued? • Disclosure requirements • Management’s responsibilities • Auditor considerations

What are Alternative Investments? • Generally, • complex in nature • limited regulation • illiquid • low correlation with standard asset classes Defined as anything that is not stocks, bonds or cash.

Types of Alternative Investment • Hedge funds • Managed futures accounts • Real estate/REITS • Commodities • Derivative contracts • Venture capital

How are Alternative Investments Valued? • FASC 820 (Old FAS 157) requires measurement at fair value, except: • Shared based payments of equity • Leases

Alternative Investments with NAV • Able to estimate fair value using NAV if the following conditions exist: • No ready determinable fair value • Investment has the certain attributes

No Ready Determinable Fair Value • No sales prices or bid-an-asked quotations are available over a securities exchange registered with the SEC • Same as above for foreign securities if not traded on comparable exchange • No fair value for mutual funds is determined and published and is basis for transactions

Investment Attributes • Primary activity is investing in assets for current income or appreciation • Unit ownership • Pooling of funds to utilize professional management • An investment company is the primary reporting entity

Fair Value Measurements for Investments with NAV • Allowed to measure fair value using the NAV, if the NAV is calculated in a manner consistent with Investment Company guidelines (FASC 946) and as of balance sheet date • If not at balance sheet date or not calculated consistent with FASC 946, must consider if adjustment is necessary • Must be applied on a per investment basis

Fair Value Measurements for Investments with NAV • If probable that a sale of an investment will occur, cannot use estimate of fair value, based on NAV, as of balance sheet date: • Management commits to plan of sale • Active program to locate a buyer • Investment is available for immediate sale • Unlikely that plans will change or that plan will be withdrawn • Must use estimated net proceeds as value

Always an Exception! • If plan to sell has been adopted, but individual securities have not been identified: • Continue to value at estimated NAV, but disclose plans to sell and any actions to complete sale

FASC 820 Refresher • Defined as price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants: • Assumes highest and best use, even if intended use is different The effect on a fair value measurement of a restriction on the sale or use of an asset by a reporting entity will differ depending on whether the restriction would be considered by market participants in pricing the asset.

Level 1 Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access. Level 1 is the highest and most reliable level in the fair value hierarchy. Example: Publicly traded security

Level 2 • Inputs to the valuation methodology include: • Quoted prices for similar assets or liabilities in active markets • Quoted prices for identical or similar assets or liabilities in inactive markets • Inputs other than quoted prices that are observable for the asset or liability • Inputs that are derived principally from or corroborated by observable market data by correlation or other means

Level 2 If the asset or liability has a specified (contractual) term, the level 2 input must be observable for substantially the full term of the asset or liability. Example: Real estate agent who pulls comparable sales to determine asking price for home.

Level 3 Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 is the lowest level of reliability. Basically, under Level 3, management is determining a value for an asset, subject to generally accepted valuation techniques.

How to Measure Fair Value Valuation techniques used to measure fair value shall be consistently applied. However, a change in a valuation technique or its application is appropriate if the change results in a measurement that is equally or more representative of fair value in the circumstances. Examples of factors that might affect valuation: a. New markets develop b. New information becomes available c. Information previously used is no longer available d. Valuation techniques improve

Classification of Investments with NAV • Ability to redeem with investee at NAV – treat as Level 2 • If no ability to redeem with investee at NAV – treat as Level 3 • Ability to change from Level 3 to Level 2 once beyond any lockup or other redemption limitation

Disclosures – Overall Objective Must disclose information that enables users of financial statements to understand the nature and risks of the investments and whether the investments are probable of being sold at amounts different from net asset value per share.

Disclosures • Must disclose by major category of investment: • Fair value • Expectation of liquidation • Unfunded commitments • Redemption terms and conditions • Any redemption limitations or restrictions • Sales or plans to sell

Major Categories • Must consider nature and risk of security. Considerations: • Activity or business sector • Vintage • Geographic concentrations • Credit quality • Economic characteristics

Fair Value • As noted, estimated of fair value, based on NAV, is allowed if: • As of balance sheet date • No plans to sell

Expectation of Liquidation By category, management’s estimation of the period of time over which the underlying investments are to be liquidated. Does the fund have a 5 or 7 year expectation?

Unfunded Commitments By major category, details of any unfunded commitment on staged investments.

Redemption Terms and Conditions A general description of the terms and conditions upon which the investor may redeem. Example: Quarterly redemption with 60 day notice By major category, any restrictions on redemptions in terms of date or amount. Management must estimate of when restrictions may lapse. If cannot estimate, must disclose how long restrictions have been in effect.

Sales or Plans to Sell • Total amount of investments under a plan to sell • Any remaining actions necessary to complete the sale • Disclosure of plans to sell if individual securities have not been identified

Management’s Responsibility AU 328.04 states: Management is responsible for making the fair value measurements and disclosures included in the financial statements. As part of fulfilling its responsibility, management needs to establish an accounting and financial reporting process for determining the fair value measurements and disclosures, select appropriate valuation methods, identify and adequately support any significant assumptions used, prepare the valuation, and ensure that the presentation and disclosure of the fair value measurements are in accordance with GAAP.

Management’s Responsibility The responsibility for determination of fair value cannot, under any circumstances, be outsourced or assigned to a party outside of the investor entity’s management. Although the investor entity’s management may look to the fund manager for the mechanics of the valuation, management must have sufficient information to evaluate and independently challenge the fund’s valuation. The underlying investments generally are measured at estimated fair value by the fund manager in accordance with its stated valuation policies for determining net asset value.

Keeping the Auditor’s Happy • More information that you have available, the easy it will be for the auditor to complete his work. • If you rely on the auditor for assistance in determining fair value: • Independence issue • Deficiency in internal control

Auditor Tool ALTERNATIVE INVESTMENTS – AUDIT CONSIDERATIONS A Practice Aid for Auditors

Auditors Areas of Emphasis • Internal controls • Existence • Valuation • Managements’ representations

Internal Control Attributes • Process to determine fair value • Availability of information used in determining estimated fair value • Nature of the investments, including complexity, liquidity and frequency • How often management interacts with the fund manager and the nature of such interactions

Internal Control Attributes • Competence and experience of management to monitor and estimate fair value • Availability of SAS 70 reports (being replaced by SSAE 16, effective for periods ending after June 15, 2011) • Use of an investment adviser to monitor the alternative investments • Availability of financial information of individual investments

Existence • Whether alternative investments exist at a given date and whether recorded transactions have occurred during a given period • Generally achieved through confirmation, but alternative procedures may be necessary

Alternative Procedures • Observing management site visits or telephone calls to investee funds (or reviewing documentation of such calls or visits) • Reviewing executed partnership, trust, limited liability corporation, or similar agreements • Inspecting other documentation supporting the investor’s interest in the fund (for example, correspondence from the fund or trustee acknowledging transactions with the fund) • Reviewing periodic statements from the fund or trustee reflecting investment activity and comparing activity with amounts recorded by the investor • Vouching relevant cash receipts and disbursements

Valuation • The valuation assertion addresses whether alternative investments are reflected in the investor entity’s financial statements at appropriate amounts • Appropriate disclosures are contained within financial statements

Management Representations Required by Auditor • Appropriateness of the measurement methods and consistency in the application of the methods • Completeness and adequacy of the disclosures related to estimated fair value information • Subsequent events requiring adjustment to the estimated fair value measurements and disclosures

Management Representation • The auditor must evaluate: • The reasonableness of significant assumptions • Whether the assumptions appropriately reflect management’s intent and ability to carry out specific courses of action

Questions?

Management’s Role in Valuing Alternative Investments with NAV’s