Running the Fund:Alternative Realities

Illustration By Charles Immer

The U.S. Department of Labor's Boston office reportedly is looking into how pension plans value alternative investments, and the investigation ultimately could lead to a new DoL requirement that fiduciaries have independent valuations of these investments done.

"There is a lot of anxiety over the actions taken by the DoL in Boston" given the potential time and expense involved, says Nell Hennessy, President and CEO of Fiduciary Counselors Inc. in Washington. The investigation comes as the issue gains momentum from several sources.

In September, some members of Congress called for new DoL guidance on pension plans' use of alternative investments, after a GAO (Government Accountability Office) study advocated the move. A working group of the DoL's ERISA Advisory Council looked at the issue of hard-to-value assets at a September meeting. The working group, formed prior to the Boston investigation, seeks to explore whether the need exists for new regulations, given that pension plans increasingly invest in assets for which there is no generally recognized market.

"The issue could be all the more urgent because of the continuing turmoil in the financial markets," says Barbara Bovbjerg, GAO Director of Education, Workforce, and Income Security issues. While the outcome of all this valuation scrutiny is unknown, for benefit-plan investors, it likely means becoming more systematic about how they handle this issue, says Chris Addy, CEO of Castle Hall Alternatives Inc., a Montreal company that does hedge fund operational due diligence for global investors. "You need to have a good due-diligence process," he says, "and you have to reach your own opinions."

Requiring independent valuations would mean a big shift. "The typical practice, industrywide—not specific to plan sponsors—is relying on the valu­ation statement provided by the manager of the fund," Addy says. That setup carries a built-in potential conflict of interest, of course, since an investment provider has an interest in having its investment performance valued highly, but that valuation can, and frequently does, influence investment managers' compensation.

Not all hard-to-value investments are alternative investments, and not all alternative investments are hard to value, points out Susan Mangiero, President of Trumbull, Connecticut-based research and analysis company Pension Governance, LLC, who testified at the September ERISA Advisory Council meeting. A hedge fund may invest in actively traded public equity, she says, while the credit crisis has revealed that some money-market funds hold complex instruments with unclear values, but there are some truisms about the hardest alternative to value, Hennessy says. She says that venture capital proves difficult, for instance, because these funds invest in start-up companies that may have little or no sales yet.