Fund Audit: What the Auditor Signs and What They Do Not

An auditor of a private fund signs one thing: an opinion on the fund's financial statements for the year, formed against a stated framework. The auditor's signature does not reach the multiples, the rate of return, the manager's letter, or what any holding will fetch. Of the six items an investor of Nilgiri Growth Partners Fund II, invented, receives, exactly one carries it.

Almost every misunderstanding about a fund audit is a misunderstanding of one word, and the word is not audit. The word is scopeThe exact set of things a signature covers, and outside which it says nothing at all.. A signature has a boundary drawn around it. Inside that boundary somebody has formed a view and put their name to it. Outside it they have said nothing, and saying nothing is not a failure or an evasion. Silence is simply what a bounded signature does. A reader who knows where the boundary runs stops asking the auditor's name to do work it was never signed to do, and that single habit is worth more than any amount of knowledge about auditing itself.

The certificate on the weighing machine at a vegetable stall makes the point. An inspector has checked the machine and stuck a sticker on it. The sticker says the machine reads honestly. The sticker does not say the tomatoes are fresh, it does not say the price is fair, and it certainly does not say what tomatoes will cost next week. Everybody understands what a weights-and-measures sticker is for, so nobody feels cheated by the silence. A fund audit gets misread constantly for the opposite reason: it sits next to a sheet of impressive numbers, and the mind quietly assumes the signature stretches across all of them.

What does an auditor of a private fund actually sign?

One document. The auditor's report carries an audit opinionA signed statement about whether a set of accounts is fairly presented on a stated basis. on the fund's financial statementsThe fund's own statement of what it holds, what it owes and what moved through it in the year. for a stated year: what it holds, what it owes, what came in, what went out, and the notes that go with all of it. A stated framework is the accounting basis the fund itself says it has used. The opinion is about whether those statements are prepared in accordance with that basis, and fair presentation against it is the whole subject of the signature.

Now hold the signature against what a reader usually hopes it means. Each refusal fails in a different way, so each one is worth saying on its own.

An audit is not a valuation. Nobody in the audit chair goes out and prices Nilgiri Growth Partners Fund II's unsold businesses independently for the purpose of the audit. Pricing an unlisted holding is a separate exercise with a separate signature on it, and confusing the two signatures is the single commonest error on the subject.

An audit is not an endorsement of the manager. The report says nothing about whether Nilgiri Alternatives Advisors Private Limited, invented, chose well, negotiated well, or ran the businesses it holds well. Skill is not what is being reported on.

An audit is not an opinion on whether the holdings are worth what the statements say they are worth. It is an opinion on whether the statements, containing those figures, are fairly presented on the basis stated. The two sentences look similar and are not the same sentence at all. The carrying value question is answered on its own below.

An audit is not a statement about what happens next. Not about the six quarters left in this invented fund's ten-year term, not about whether a buyer appears, not about anything after the date the statements are drawn to. The word fair presentationThat the statements show the position on the basis the fund says it has used. points backwards at a period that has finished, never forwards.

Every other service provider in this worked case has a name. Kolar Fund Services Private Limited, invented, is the administrator. Palani Valuation Advisors LLP, an invented limited liability partnership (LLP), is the independent valuation agent. Nilgiri Trusteeship Services Private Limited, invented, is the trustee. An impression of a particular audit firm is exactly the thing a reader should not be collecting, so the statutory auditor has no name, invented or otherwise. Throughout, it is simply the fund's statutory auditor.

Which one of the six things an investor receives carries an opinion?

An investor of Nilgiri Growth Partners Fund II, invented, receives six different things across a year, and they arrive on different rhythms from different desks. Sorting the six is where the difficulty lies, and once the sort is clear the rest follows.

Here they are, numbered as this fund's own arrangement numbers them. One, a capital account statement each quarter. Two, a quarterly report, arriving within a number of days of quarter end fixed by the fund's own documents. Three, an audited annual report. Four, a letter from the manager alongside the quarterly numbers. Five, a notice for every capital call and every distribution. Six, an annual valuation report from the independent valuation agent.

Item three carries an audit opinion and no other item does. One of six is 16.7 per cent of what arrives. The other five, being 83.3 per cent of what lands in front of an investor across a year, carry no audit opinion at all. The weighting is counter-intuitive. Most of what is read about this fund, most of the material, most of the numbers an analyst would quote to a colleague, arrive with nobody outside the manager having formed any opinion on them.

Is the quarterly report audited, and what does unaudited mean?

No, and this fund's own quarterly report says so on its face. The document is named and described as unauditedNot covered by an auditor's opinion, which most of a reporting pack is not. in a single breath. Most readers hear the word as an apology. The word is not an apology, and it is doing something precise enough to be worth slowing down on.

Unaudited is a statement about scope, not a statement about quality. The word says: no auditor has formed an opinion on this document. The word does not say the figures were produced carelessly, it does not say they differ from the ones that will appear in the annual report, and it does not say anybody expects them to be wrong. The quarterly numbers of Nilgiri Growth Partners Fund II, invented, are struck by Kolar Fund Services Private Limited, invented, the administrator, from the fund's own records, exactly as the annual ones are.

The everyday version: an electricity bill and a bank statement both come from outside the household, and neither is audited. Nobody treats a bank statement as unreliable because no auditor signed it. A bank statement is taken for what it is, a record produced by somebody with systems for producing records, and an audit is reached for only when somebody independent is needed to form a view on how the whole set of records was put together. Unaudited means an opinion was not sought, not that a number was not taken seriously.

There is a second half to this, and it cuts the other way. Because no opinion stands behind the quarterly pack, nothing about the quarterly pack has been through anybody outside the manager and the administrator. A reader who wants that comfort has to wait for the annual report, and then has to be precise about what the annual report actually covers.

What sits outside the opinion even when the statements are inside it?

The things listed below all appear in the same reporting pack, often side by side, sometimes in a larger typeface than anything the auditor ever looked at. Appearing near a signature is not the same as being under it.

Six things sit outside the opinion on Nilgiri Growth Partners Fund II, invented, at the end of its Year 9 Quarter 2, and they are worth numbering because all six are commonly met.

One, the multiples. Nilgiri Growth Partners Fund II, invented, reports at the end of its Year 9 Quarter 2 a total value of 1.80 times its Rs 4,00,00,00,000 of acquisition cost, 1.50 times the Rs 4,80,00,00,000 of capital actually paid in, and 1.44 times the Rs 5,00,00,00,000 of total commitments, all three on the same day about the same fund. Every one of them is a ratio computed from the statements rather than a line in them.

Two, the rate of return. Nilgiri Growth Partners Fund II, invented, reports 8.3 per cent net to investors at the end of its Year 9 Quarter 2. The rate of return is arithmetic run over the fund's own cash dates and its closing value, not a statement of account.

Three, the public market comparison. Nilgiri Growth Partners Fund II, invented, reports a public market equivalent of 1.05 at the end of its Year 9 Quarter 2 against a reference broad equity index that is itself invented and is not any real index, using the method of Kaplan and Schoar. Same story: computed from the statements and from an index, not part of them.

Four, the manager's letter and everything characterised in it. Five, anything at all about the six quarters remaining in the fund's term. Six, whether the Rs 2,82,00,00,000 of carrying value is ever received in cash.

Every one of those six is arithmetic or prose sitting beside the statements, and a signature on the statements does not travel sideways into the things computed from them. The reason is not a technicality about auditing. The reason is that a ratio has a denominator somebody chose, and a comparison has a benchmark somebody chose, and choosing is not the same activity as recording.

How is an audit opinion different from a valuation opinion?

Two signatures arrive in the same year, about the same fund, and they are read as one signature more often than any other mistake on this subject. Take them apart.

A valuation opinionA signed statement by a valuer about what a holding would change hands for on a stated date. is signed by Rohit Vaz, the signing partner at Palani Valuation Advisors LLP, invented, the independent valuation agent for Nilgiri Growth Partners Fund II, invented. A valuation opinion is about one thing: what an unrealised holding would change hands for on a stated date. The valuation report arrives as item six of the six things an investor receives. Rohit Vaz is not the auditor and has never been the auditor.

An audit opinion is signed by the fund's statutory auditor and is about whether the financial statements as a whole are fairly presented on the stated basis. The auditor's report arrives inside item three.

Three parties stand near the numbers on this fund and it is worth being brutally clear that the auditor is not any of them. Palani Valuation Advisors LLP, invented, values every unrealised holding once a year. The manager marks the holdings quarterly in between those annual valuations. Kolar Fund Services Private Limited, invented, the administrator, strikes the net asset value. The auditor is not the valuer, not the marker and not the administrator, and every one of those three jobs is somebody else's signature or somebody else's routine. How the valuation machinery actually works, and why a private mark moves later than a public price, are covered separately and are used here without being explained.

Is the carrying value of an unsold holding confirmed by the signature?

Here is the position, stated plainly first. At the end of its Year 9 Quarter 2, Nilgiri Growth Partners Fund II, invented, reports Rs 2,82,00,00,000 of residual value across five unrealised holdings. Not one of those five has been sold to anybody. One of them, Vaigai Edutech Private Limited, invented, is carried at Rs 21,00,00,000 against the Rs 30,00,00,000 it cost, being 0.70 times cost. The five together cost Rs 1,80,00,00,000 and are carried by that same invented fund at that same record date at 1.57 times that cost. Against the Rs 7,20,00,00,000 of total value Nilgiri Growth Partners Fund II, invented, reports at the end of its Year 9 Quarter 2, the Rs 2,82,00,00,000 that has never been sold is 39.2 per cent.

Now the question. The carrying value is inside the statements, so the opinion does reach it, in the sense that the opinion is about whether statements containing that figure are fairly presented on the stated basis. The opinion is not a confirmation that any holding will be sold for what it is carried at. An audit does not turn an estimate into a tested number, and Rs 2,82,00,00,000 of this invented fund's value remains an estimate that has been prepared, reviewed and signed off while no buyer has priced it.

The cleanest proof the record of Nilgiri Growth Partners Fund II, invented, offers is its holding 3, Tungabhadra Logistics Private Limited, invented. Tungabhadra Logistics cost Rs 60,00,00,000. At that fund's Year 7 year end it was carried at Rs 1,20,00,00,000, being 2.00 times that cost. In that fund's Year 8 Quarter 1 it was sold for Rs 1,50,00,00,000, being 2.50 times that cost. The figure the fund reported for that business moved by Rs 30,00,00,000 on the day it was sold, worth 25.0 per cent of the carrying value and half a turn of cost. An opinion had been signed over the year in between.

Nothing in that sequence was contradicted by anything else in it. A carrying value is a measurement on a stated date on a stated basis. A completed sale is a different measurement of a different event on a different day. Reading the second as proof that the first was wrong is like saying the tailor mismeasured a shirt because its owner weighed more at the wedding than at the fitting.

What goes wrong when a clean opinion is read as a verdict?

What does the annual report give that the quarterly pack does not?

Put the year on a line. Four times, this invented fund's investors receive a capital account statement, an unaudited quarterly report and a letter from the manager. Once, they receive an annual report with an opinion inside it. The temptation is to assume the annual figures are somehow better figures. The annual figures are not better figures. The annual figures are the same kind of figures with a different thing standing behind them.

The numbers do not change. The basis does. Across the year, everything an investor sees has been produced inside the arrangement between the manager and the administrator. Once a year, somebody outside that arrangement forms and signs an opinion about whether the statements of the fund are fairly presented on the basis the fund says it uses. The annual report does not improve a single figure in the four quarterly packs; what it adds is that the basis behind the year has been opined on by somebody who is not the manager.

The gain is real and smaller than most readers assume, so both halves are worth stating. The gain: a reader now knows that the recording and presentation of a whole year has been through an independent process. The limit: that process was never about the multiples, the rate of return, the letter, or what any of the five unsold holdings of Nilgiri Growth Partners Fund II, invented, will eventually fetch.

What does somebody who does this for a living do with an audit?

The most useful thing anybody in this worked case does with an audit is not to read the current one. The useful thing is to ask about all of them.

Investor 5 of Nilgiri Growth Partners Fund II, invented, is a fund of funds. Before it committed, it ran operational diligence on Nilgiri Alternatives Advisors Private Limited, invented, meaning diligence on the manager as an operating business rather than diligence on any investment. Operational diligence tested a list of things: the administrator's independence, the valuation process, who can move cash and how many people it takes, the business continuity arrangement, and one question about the auditor. The question was whether the auditor had ever issued anything other than a clean opinion.

Of every use of an audit in this worked case, that question is the sharpest, and its shape is worth sitting with. The question asks about the history of the opinions rather than about the current one, and the history is precisely what makes it worth asking. The current opinion tells a reader almost nothing they can act on, for every reason set out above. A run of years with nothing qualified in any of them, or a year somewhere in the middle where something was qualified, is a fact about how a manager has recorded and presented its affairs over time. A run of years like that is an operational fact, not a performance fact, and operational diligence is where it belongs.

The record holds that the question was asked and does not hold what came back, so what the answer was for this manager is not known. Nor does either answer, by itself, carry a conclusion for a reader. And asking gives nobody protection: an operational question produces information, and what anybody does with information is a separate matter.

An analyst reading a private fund's pack for the first time can borrow the same habit at a smaller scale. Do not look at this year's signature and feel reassured. Look at what the signature is about, then ask separately about the run of years behind it. Scope and history are two different facts, and only one of them is printed in the pack at hand.

If there is one question to ask about any signed document, what is it?

Ask what exactly is inside the scope of the signature. Not who signed it, not how senior they are, not how long the report is. Only what is inside.

The answer to that one question does something no amount of general knowledge does: it settles immediately which of a reader's own questions the document in hand can reach, and which it cannot touch at all. A valuation report asked whether the manager is competent gives silence, correctly. An auditor's report asked what a holding will sell for gives silence, correctly. Both documents are doing their job. The reader who is disappointed has simply asked the wrong document.

On a private fund's reporting pack there are only three answers met in practice, and all three are recognisable on sight. The auditor's report answers with the financial statements for the year, on a stated basis. The valuation report answers with what one unrealised holding would change hands for on a stated date. The manager's letter, the call and distribution notices and the whole of the quarterly pack answer nothing at all.

Who signed matters far less than what they signed about, and on a private fund's reporting the two commonest signatures cover completely different things.