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Hedge Funds Return to Mark to Model: Duff & Phelps

Date: Wednesday, November 5, 2008
Author: Laurence Fletcher, Thomson Reuters.com

Hedge funds are starting to move back to the practice of marking complex structured credit instruments to their financial models because market prices are unreliable, says financial advisory firm Duff & Phelps.

James De Bono, managing director at Duff & Phelps, London, which helps hedge funds and banks value assets, told Reuters in an interview that funds are moving to marking to model because in illiquid markets the range of broker prices can be too wide to be very meaningful.

The valuation of hedge funds' holdings has become an increasingly important issue as liquidity dries up for some assets markets while hedge funds themselves face redemption pressures.

"Given there are less market prices within certain markets for certain products, we've moved onto marking to model…. Previously the effort was more to getting a market price," Mr. de Bono said. "If there are prices, it should help you in calibrating that model."

He said the changes had taken place "within the last couple of weeks."

The move shows hedge funds are beginning to follow the example set by regulators, who have in recent weeks endorsed marking to model rather than marking to market or fair value accounting.

While some investors believe fair value makes the true value of a company or a fund's holdings clearer, many market participants say it does not reflect the substance of transactions in illiquid markets.

Last month European Union accounting regulators voted to ease mark-to-market rules blamed by the bloc's leaders for exacerbating the credit crisis.

Meanwhile, the U.S. Securities and Exchange Commission issued guidance saying banks in the United States need not use fire-sale prices when evaluating some hard-to-price assets.

By Laurence Fletcher