Definition

The appraisal project is a thorough review and assessment of the “non-investment” risks present at a hedge fund.

The “non-investment” risks are defined as the risks linked to the implementation of the fund’s investment strategy. Those risks encompass operational risks, fraud risk, business risk and legal risk.

The objective

The objective of the project is to identify areas of vulnerability which may lead to the occurrence of a low probability high impact event.  

The process

Our appraisal process is based in two interconnected pillars: the information collection and the information analysis.

The quality and type of information used to appraise a fund is critical (“Garbage In, Garbage Out”).

In designing our process, we have been very careful at striking the right balance between information quality versus information quantity. The devil is sometimes in the details but the details may also lead to information over-kill.

We focus on collecting actionable information which will allow us to reach the right conclusions. We have identified a set of proxies which provide us an indirect way for checking and verifying relevant information.

Our data collection is based on four different sources of information:

• Documentation review/Desk research 
• Service providers’ appraisal questionnaires
• Background check
• Onsite visit

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The information analysis is supported by our proprietary Appraisal database. The database is used to record, organize and analyze the large quantity of information that we collect on the funds (on average 300 fields). In order to control for the information independence and integrity, each piece of information in the database is linked its source (document, call recording, onsite visit report …). The data is organized around the following categories:

Assets protection (counterparty management, cash management, assets confirmation, assets liquidity …)

Fund Incorporation/Capital Structure (structure, voting rights, corporate governance …)

Fund Strategy (investment strategy, type of assets traded, portfolio construction, turnover, staff …)

Fund terms (redemption, subscription, fees, lock up, side pocket …)

Portfolio pricing (pricing policy, independence, escalation procedure, positions reporting …)

NAV calculation (manager intervention, timing, communication with investors, oversight …)

Investment Manager (structure, licenses, total AUM, products, staff, business model, management…)

Trading (trade flow, systems, staff, trading authorization, order split, cross-trading, best execution…)

Compliance/Legal (staff, compliance manual, trading by employees, compliance program, training …)

IT/Disaster Recovery (backups, alternative site, testing, disaster recovery plan, staff …)

Back office/middle office (portfolio management system, reconciliation, settlement, trade confirmation, cash transfer, finance, treasury …)

Risk management (staff, methodology, oversight, independence, system ….)

Service providers (relationship duration, role confirmation, service provided …)

We perform a quantitative analysis of the fund in order to check statistics like correlation, volatility, returns … for inconsistency with the manager’s peer group. We  also look at indicator for return smoothing and price manipulation like the auto-correlation and the bias ratio.

The timeframe

A project is usually completed within 4-6 weeks.!