Custody Risk #3: Lack of accurate and timely fund pricing

July 22nd, 2013 Posted by Opinion 0 comments on “Custody Risk #3: Lack of accurate and timely fund pricing”

Pricing remains a key consideration for custodians of alternative assets. By this we don’t mean the price that custodians charge for a transaction, although the cost to process a trade into or out of an alternative fund is higher than for an equity or a bond. The main issue here is procuring the actual fund’s NAV in a timely and accurate format. This valuation is particularly important, because it is used for calculating fees.

The calculation of custody fees needs to be transparent and consistent with the other services offered by the custodian. The cost involved in procuring a price for a traditional security is negligible – many prices are free, and vanilla securities also have the benefit of a reliable security ID code. The pricing of traditional securities can be carried out quickly, with clearly defined data sources and consistent prices. For hedge funds, the picture is much more opaque.

Where to find the data?

For alternative assets, procuring a price represents a much larger challenge, as there is no single data provider that can be consistently accessed.

  • Traditional securities data vendors publish the prices of those alternative funds that report directly to them, but pricing is frequently delayed and the funds covered do not represent a sufficient segment of the universe custodians need.
  • Specialist hedge fund databases cover a much larger slice of the universe, but rely on funds to report data to them. If a fund chooses not to report, or stops reporting (for example if it closes to new investment), the data series becomes incomplete.
  • Custodians can hire a third party agent to procure prices from fund managers on their behalf, but this can be an expensive and time consuming process.
  • Alternatively, custodians can go direct to the funds themselves, but this requires considerable investment in terms of time, money and manpower internally.

On top of the above data-related challenges is the fact that accurate pricing is required for a range of tasks, including for loans, bridging finance and leverage. Pricing hedge funds effectively for such functions is still a much greater problem for custodians than it should be.

For example, no electronic feed exists that can readily integrate with other data systems, causing custodians to rely on manual processes, which are slow and prone to errors. Audit trails to prove a price is accurate are both time consuming and expensive. In addition there is a huge burden of associated documentation to be managed.

Financing can be a much more lucrative business for custodians than plain vanilla custody, but even here, lending against alternative assets can be fraught with risks because of pricing issues. Because of the illiquid nature of alternative investments, investors sometimes need to borrow against holdings that are in the process of being redeemed in order to be able to re-invest assets. Such interim funding is frequently provided by custodians because they hold the assets, but this also puts pressure on the custodian to ensure accurate pricing and a detailed picture of the redemption time horizon. Ultimately, the lack of a consistent pricing picture represents a significant risk to the lending side of the custodian’s business.

For more information on how Comada can help you with your custody related risks, please contact Stuart Fieldhouse at

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