Recent events in the hedge fund industry have taken off-guard a lot of investors who suddenly realized that their due diligence process was not comprehensive enough to assess all the risks involved in Hedge Fund investing.
Investors have now to rethink their approach to manager selection in order to properly assess the full risk/reward of the funds and to manage the emergence of any conflict of interest in the selection process.
Due Diligence Process Diagnosis and Restructuring. Get a full review of your current due diligence process and a road map for changes to improve its efficiency.
Manager Selection Process Review. Without a proper framework in place even the best due diligence process will lead you to the wrong fund managers.
Training. Get a personal trainer for your due diligence team.
Ad-hoc due diligence project.
Know Your Manager (KYM) is a very important part of any due diligence process. Our thorough background check encompasses key individuals with the investment manager, the investment manager’s entities and the fund’s entities. Our dedicated team searches over sixty websites and public databases for relevant information.
Our background check includes:
For entities:
o Incorporation Check
o Licenses verification
o Legal Check for past and current cases
o Media search for “adverse” news
For individuals:
o Last university degree and professional designation verification
o Last employer confirmation
o Legal Check for past and current cases
o Media search for “adverse” news
o References checks using contacts given by the company and using our own extensive network
The background check service can be bought as a standalone service or is also provided as an integral part of the operational risks appraisal report.
In order to uncover the operational risks involved in a particular hedge fund, we are implementing a thorough and rigorous process based on multiple source of information. At Hedge Fund Appraisal, we think that all the fund’s stakeholders have to be involved in order to get a complete and reliable picture of the fund.
The process is divided in three main tasks:
Information Collection
•Colletion of information from multiple sources •Offering Documents, Proprietary Due Diligence questionnaires, Investment Manager Information, Background Check •On-site visit
Information Synthesis
•Synthesis of the information in our proprietary database •Categories reviewed:Assets/Custodians, Business Recovery Plan, Cash Transfers, Compliance, Independence, NAV Calculation/Reporting, Portfolio Pricing, Back-Office, Redemption, Service Agreements and trading
Risks Assessment
•Risks assessment using our risk model •Final Report, Warning Report, Risks rating
The turnover time to perform an operational appraisal is usually 6 weeks. The report is organized in an easy-to-read table format and all the information is mapped to its reference. All the documentation used during the appraisal process is made available to the client for future reference.
The objective of the investment risk appraisal is to assess the risks involved in the strategy and the quality of the risk management in place to mitigate those risks
The appraisal will combine the quantitative and qualitative approaches:
Quantitative Approach
Hedge Funds' returns are known for their assymetry. The use of traditional risk measures could therefore underestimate the real risk of the strategy. Our strong analytical skills allow us to choose the appropriate set of traditional and non-traditional statistics to analyze a fund's track record
Qualitative Approach
Returns are generated by the exposure to rewarding risks and by the manager skills also called Alpha. The investor need to ensure that the risks taken are in-line with the strategy implemented and that the risk manager has the adequate procedure, skills and tools in place to assess and monitor the fund's risk exposures. For example, the track return of an option seller will not always be indicative of the real risk of the strategy.
A lot of Fund of funds managers have failed to justify their fees last year with a lot of them being caught in the different fraud scandals and by their inability to add alpha over the different recognized hedge fund indices.
The Appraisal will focus principally in the three following topics:
Manager Alpha
The fund of hedge funds manager can add alpha in different manners through his choice of funds and the management of the portfolio. It is key to understand the real source of alpha, if any, of the manager in order to assess properly its legitimity and replicability.
Due Diligence Process
The selection of good managers has to be supported by a strong due diligence process. The quality of the process is judged on the ressources allocated to it, the methodology in place and the tools developped to translate the raw information into investment decision.
Manager Selection Process
Managers have to be selected for the good reasons. The conflicts of interest that too often influence investment decision have to be avoided or at least properly managed and disclosed.
