Valuation of Complex, Illiquid Instruments

CMRA has been a leader in promoting good valuation practices as well as providing valuations of complex financial instruments both in an advisory/consulting capacity and as an expert in litigation. CMRA coined the term "mark to model" and is widely respected as an expert in both market and model based valuation and in best practices and governance related to their application.

Selected Valuation Assignments

• Reviewed the CLO valuation and risk management approach for a major broker/dealer
• Valued a portfolio of complex and illiquid asset backed securities
• Reviewed CDO valuation practices for several institutional clients
• Vetted many complex pricing models
• Analyzed by the valuations in a litigation relating to margin calls on an MBS hedge fund for a large broker/dealer
• Provided a "fair value" opinion to a large bank regarding illiquid securities
• Valued a portfolio of complex investments including derivatives for a major insurance company planning an acquisition
• Provided expert consulting in a merger regarding the valuation of complex assets
• Provided expert report and testimony on behalf of a large European bank in an arbitration related to the valuation and profitability of an unusually long term option
• Provided an expert report regarding issues related to pricing of illiquid exchange traded options
• Advised on valuations and market practice issues on the unwind of an emerging market hedge fund with over 100 derivative in positions including total return swaps (TRS) and credit default swaps (CDS)
• Analyzed and priced over 30,000 FX options and forwards
• Provided advice regarding the valuation of a purchasing option embedded in a contract
• Provided valuation and market practice expert report and testimony in litigation related to Askin/Granite funds meltdown

Recent and Upcoming Speeches re: Valuation

October 2008

June 2008

April 2008

March 2008

Selected Articles re: Valuation

• The biggest "CIO" Risk - Alpha" Risk Manager" (complex, illiquid, opaque) - AIMA Journal – Feb. 2008
• Hedge Fund Transparency-Unravelling the Complex and Controversial Debate – Risk Books – March 2003
• NAV/Fair Value Practices - LSTA Loan Market Chronicle – Feb. 2002
• NAV/Fair Value Practices Survey Results - The Journal of Alternative Investments – Winter 2001
• Head Fund Transparency: qualifying valuation bias for illiquid assets – Risk – June 2002

Selected CMRA in the Press re: Valuation

Opinions Diverge on Who Calls Valuation Shots When Liquidity is Scarce
Martin de Sa'Pinto, Senior Financial Correspondent

MONTE CARLO, Monaco - The liquidity crunch brought home to many investors, portfolio managers, service providers and prime brokers how sharply valuations can diverge when a portfolio becomes unexpectedly illiquid. This was particularly true for highly leveraged portfolios that, as the result of not-always-sharp fluctuations in the prices of securities, found themselves facing margin calls and forced to unwind positions rapidly.

The complexity of the security in question is clearly an issue, and when there is a lack of consensus on valuation methods, different constituencies will often make a strong case for completely distinct methods that can produce widely diverging valuations.

This was the basis for a panel discussion at the Global Alternative Investment Management conference in Monaco on June 19 was moderated by Henny Sender, international financial correspondent at the Financial Times.

"Valuation and transparency are among the hottest topics facing hedge funds and investors today," said Ms. Sender in her introduction. "How quickly can valuations change? If you don't have a good sense of valuation you cannot manage the risk of your positions."

In such circumstances, "I was a diehard advocate for mark-to-market, and I still believe it's the lesser of evils, but there are times when model-based pricing might make sense," said Ms. Rahl. This would of course imply that the model-based methodology was favored over mark-to-market because either market prices were stale or unavailable, or the relationship between the underlying and the proxy was weak. "The option of using such a valuation methodology would require strict checks and balances within a fund," she said.

"Marks on the collateral don't necessarily represent the price at which a trade can be unwound," said Ms. Rahl. "In some situations we have seen the exact same trades with two different counterparties being unwound at vastly different prices."

Ms. Rahl said relevant documentation, including research reports, broker quotes and screen shots, should be printed out and kept on file so that it is at least available in the case of a dispute.
(July 2008)

Global Investment Technology
Buy-Side Group Outlines Risk Management Best Practices

NEW YORK - Governance, investment and operations personnel in the securities and investments industry will have all to adhere to certain principles to best manage risk, according to the Buy Side Risk Managers Forum and Capital Market Risk Advisors (CMRA), a consultancy.

The forum, a group of heads of risk managements and chief risk officers from traditional buy-side asset and investment management firms, recently issued a set of risk principles within each of these three areas, titled "Risk Principles for Asset Managers."

"This piece is an important update, "says Leslie Rahl, President of the consultancy CMRA and a member of the forum. "Risk management is a journey not a destination. It's something that keeps going and keeps needing updates."

Governance risk principles concern organizational structure and oversight mechanisms, including the importance of independent controls, segregation of functions, senior management involvement in risk management and oversight and adoption of appropriate policies and procedures.

Investment risk principles relate to the need for risk controls at the portfolio level, and address market risk, liquidity risk, leverage, valuations and other aspects.

Operational risk principles concern risk occurring in the ordinary course of business and in disasters. These address identifying, assessing and monitoring such risks, setting up adequate systems and minimizing manual processes, managing counterparty credit risk and assuring business continuity in a disaster.

"These principles recognize the broader function for risk management, which is not just computing the numbers and tracking the limits, but the proactive functions that help firms optimize the relationship between risk and rewards," says Rahl. "The emphasis on governance has evolved. The focus on governance is clearly something that the regulators are looking for and where the industry is evolving. The principles should provide an important framework for best practice risk management. The discussion of risk governance and valuation are particularly critical in today's market environment."
(March 17, 2008)

Market volatility puts risk at forefront
By Jay Cooper

"In general, liquidity doesn't enter into the metrics used by pension funds," said Leslie Rahl, president of Capital Market Risk Advisors, a New York-based financial advisory firm specializing in risk management.

"In times like these, non-quantitative measures need to supplement normal risk reporting. The best defense is asset allocation, manager selection and effective risk due diligence," she added.

As part of their due diligence process, pension fund officials should also be asking managers how they value instruments like CDOs that do not trade on a liquid market, Ms. Rahl said. She said pension executives should be wary of managers who allow the trader to value those securities themselves.
(August 20, 2007)

The calm after the storm - or the eye of the hurricane?
By Suzanne McGee

"We can't rewind the clock and go back to the environment where people felt as carefree as they seemed to in the first month or two of 2007," says Leslie Rahl, a founder of Capital Market Risk Advisors, a firm that has advised financial institutions on managing all kinds of risks since the mid-1990s, when the first derivative debacles roiled financial markets.

Rahl isn't fielding calls from clients desperate to extricate themselves from the fallout of a risk misjudgment. Still, she sees the turmoil of late February and early March as the first stage in a global repricing of risk that is long overdue, and she is urging those clients to "stress test" their portfolios in anticipation of more upheaval.

"While I don't sense that the market believes today that this is imminent, there is general agreement that it has to happen; in some markets, risk premia are as tight as they have ever been," Rahl says. "I think the future is more fragile than the market is pricing it today, and the biggest lesson of the subprime market's implosion so far is how quickly risk can be repriced."
(April 9, 2007)

Hidden risk: Investors skim over question of fund valuation
By Christine Williamson

``With so much money rushing into hedge funds, people are very anxious about preserving capacity and that's when they begin to cut corners, when it becomes more of a seller's market. But it's the fiduciary responsibility of (institutional) investors to make sure that their fund-of-funds managers are asking all of the right questions about the process of due diligence and portfolio construction, including valuation. It's a bad assumption to think that all fund-of-funds companies are conducting the right level of analysis on the hedge funds they use,'' said Leslie Rahl, president and chief executive officer of Capital Market Risk Advisors LLC, New York, a hedge fund risk analysis firm and consultant.

``There is enormous interest in this area, but there is still a lot of education to be done of both investors and managers,'' said CMRA's Ms. Rahl. ``There are a lot of nuances that people are not fully comprehending. Questions have to be very carefully tailored for each kind of strategy. Valuation is an issue any time you have an instrument that's not traded in a transparent, liquid market. Intelligent, well-meaning people will often price the same securities very differently.''

The Investor Risk Committee of the International Association of Financial Engineers, Washington, for example, released a white paper on hedge fund portfolio valuation recommendations in early June. Ms. Rahl has served on the IAFE committee that worked on the recommendations for the past two years and co-chaired it last year.
(July 12, 2004)

Wall St. takes stock five years after LTCM crisis
By Eric Burroughs

"LTCM increased the amount of transparency from hedge funds, but it's not very well defined," said Leslie Rahl, a partner at Capital Market Risk Advisors, a New York-based risk management advisory firm.

"The whole issue of valuation is a big one," she said, particularly for instruments ranging from mortgage-backed securities to many derivatives for which trading is not always active and price quotes can vary greatly.
(September 26, 2003)

Third-parties fill the gap - RISK MANAGEMENT
by Geoff Nairn

Boutique consultancies, specialising in risk management, have sprung up in the past couple of years. Their target is the smaller institutions that cannot maintain a small army of risk specialists on their payrolls.

One such consultancy, New York-based Capital Market Risk Advisors, offers outsourcing capabilities in areas such as risk monitoring, vetting of risk models and quarterly reporting to investors or trustees.
(June 30, 2003)

AIMA Releases Fund of Funds Guidebook
By Susan L. Barreto

The Alternative Investment Management Association Ltd. has released the results of the research on hedge fund of funds it commissioned in 2001, complete with commentary from practitioners.

A 96-page book, "A Guide to Fund of Hedge Funds Management and Investment," covers a broad range of topics including risk management, transparency, hedge fund selection and benchmarking, liquidity, fees and due diligence.

Capital Market Risk Advisors, New York conducted the research, parts of which have been released throughout the year. CMRA coordinated and co-edited the guide that includes three comprehensive surveys of institutional investors, hedge funds and hedge funds of funds completed in the last year.
(October 21, 2002)

Buffett Unit's Exodus From Derivatives Raises Questions

"There is no doubt that the less liquid and more exotic the derivatives position, the more subjective the estimate of value is. Clearly, that was an issue at Enron in some of their positions," said Leslie Rahl, president of Capital Market Risk Advisors Inc., a New York derivatives consulting firm.

She said derivatives is "a business you either have to be in with commitment, and willing to take the risks in return for the rewards that can be repeated and willing to grow it, or it's probably not worth the effort to do it in a small way, because you need a tremendous amount of infrastructure, whether you have one deal or thousands."
(May 10, 2002)

Fair value pricing can be fairly unfair: Money managers rely on little price info

What is fair value when it comes to the price of a portfolio?

Scarcely any agreement exists on the issue among mutual funds, hedge funds, funds of funds and traditional money managers, according to a study by Capital Management Risk Advisers Inc. in New York.

More than 60 financial institutions - with combined assets of about $2 trillion - participated in the study.

It's an issue that doesn't get much attention, but it is one that does have an affect on portfolio's returns, says Leslie Rahl, president of Capital Management.

"If you don't even agree on what the portfolio is valued at today, how can you agree on what the risk is that it might lose money tomorrow?" says Ms. Rahl.
(July 30, 2001)