A Securities and Exchange Commission investigation found that two funds sponsored by Oppenheimer were involved in fraudulent valuations. Oppenheimer sent out misleading quarterly reports and marketing materials stating that the fund’s holdings of other private equity funds were valued “based on the underlying managers’ estimated values.” But that was not always true. The portfolio manager actually valued one of the fund’s largest investment at a significant increase over the underlying manager’s estimated value. That change that made the fund’s performance appear significantly better.
I don’t think the problem is that the fund of funds didn’t use the valuation provided by the underlying fund manager. The big problem is that the fund manager used a valuation method different than the one disclosed to investors. That problem was exacerbated by the result being an increase in valuation which led to better performance numbers in marketing materials.
Can a fund of fund use a valuation different than the one supplied by the underlying manager? I think so. But you would need to justify the difference.
One reason for using a different valuation would be timing. Given the time the underlying manager has to provide performance results, the fund of fund manager may have to start with stale information based on the prior quarter’s financial report. Then the manager could then increase or decrease the valuation based on estimated changes during the gap between the underlying manager’s report and the fund of fund manager’s report.
Another reason would be a perceived flaw in the underlying fund manager’s valuation. This change is one in which it is easier to justify a decrease rather than an increase. The fund of fund manager may find the valuation too aggressive or disagree with the underlying assumptions that went into the valuation.
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