Northbridge Special Situations: an affiliate valuer, a down round and a large redemption
Northbridge Special Situations Fund is a Category III AIF with a corpus of INR 400 crore and a stated policy of declaring NAV monthly. Twenty-two percent of its assets are unlisted convertible debentures of a logistics company. That company has just completed a funding round at a 40% lower valuation than Northbridge's entry price; the round was led by an unrelated financial investor taking a 9% stake. The manager's valuation committee, chaired by the fund's chief financial officer, wants to hold the debentures at cost until exit, partly because an investor holding INR 60 crore has asked to redeem at last month's NAV. The manager also proposes to appoint its own affiliate, a chartered accountancy firm that earns INR 1.2 crore of annual advisory fees from the manager, as the independent valuer, and to amend the valuation policy to 'cost until realisation' with effect from the start of the year. The scheme's auditor has flagged the plan, and the trustee wants to know whether the amendment can proceed before the next NAV date.
1. Can the manager's affiliate act as the independent valuer? What should be done instead?
Read the worked answer
No. The affiliate is not independent in substance: it is controlled by or associated with the manager and earns INR 1.2 crore a year in advisory fees from that manager. That is a material, continuing financial relationship, and it creates a self-review threat - the valuer would be checking numbers influenced by the party paying it.
For unlisted securities the valuation must come from an independent valuer with no material relationship with the AIF, the manager or the sponsor. The remedy is to appoint a genuinely independent firm, document the selection process and fee, and keep the valuation committee's role to reviewing methodology, assumptions and comparables rather than dictating a number. The CFO can chair an internal review, but should not instruct the valuer.
If the affiliate has already performed any valuation, those marks should be treated as unaudited and re-performed by the independent valuer. The trustee should minute the conflict and the replacement, and the manager should check whether the relationship was disclosed in the placement memorandum.
2. Is holding the debentures at cost defensible given the down round? What evidence should drive the mark?
Read the worked answer
Holding at cost is not defensible here. Valuation must reflect fair value, and a recent arm's-length transaction in the same company - a 40% lower round led by an unrelated financial investor - is primary evidence. Cost is only a starting proxy where no better evidence exists.
The mark should be rebuilt from the new round, adjusted for instrument differences: the holding is convertible debentures, not equity, so the analysis must reflect credit spread, coupon, conversion terms, seniority, liquidation preference and the probability that conversion is out of the money. A simple 40% haircut may be as wrong as no haircut; the point is that the mark must move on evidence.
The redemption request for INR 60 crore is precisely why the mark cannot be smoothed: holding NAV up transfers value from continuing investors to the exiting one. The valuation committee should document comparables, the adjustment method and its conclusion, and disclose the revised NAV to all investors. Marking to cost to protect NAV is smoothing, and smoothing is a misstatement risk.
3. Can the valuation policy be amended with retrospective effect, and how should the redemption be handled?
Read the worked answer
No retrospective amendment. A change from fair value to 'cost until realisation' applied from the start of the year would rewrite previously reported NAVs and reverse a writedown, which is a misstatement and a conflict of interest. Policy changes operate prospectively, need a valid rationale, must be disclosed to investors, and a material change should be taken to investors for consent under the fund documents (with trustee oversight). Amending the policy in the same week as a writedown decision and a redemption request will be seen as outcome-driven.
On the redemption: the investor is entitled to the fair NAV for the relevant redemption date, computed under a valid policy by an independent valuer. If illiquid assets make a cash payment unfair to remaining investors, use the disclosed gates, suspension or in-specie distribution mechanics in the documents - not a manipulated NAV.
The trustee should minute the decision, obtain valuer and auditor input, and the manager should consider reporting the material valuation correction to SEBI and to all investors rather than quietly restating.