Hedge Fund Due Diligence
Check back each month to read the latest proprietary study addressing issues in due diligence and risk analysis.
- Operational Due Diligence 3.0: Responding to a Regulated and Institutional Alternative Asset Industry
As the alternative asset industry has grown and matured, the discipline of operational due diligence (“ODD”) has become more prominent. Alternative asset investors no longer make decisions based on investment performance alone: allocators are focused equally on the risk of operational failure — be it through honest error, or in the worst case, through dishonesty and fraud.
Against this background, ODD, often an optional luxury before 2008, has become a mandatory component of alternative asset investing. Hedge funds and Private Equity managers are no longer “different”, and institutional investors, often subject to fiduciary obligations, cannot accept lower operational standards simply because they are allocating to an alternative manager. As a result, it is becoming a baseline assumption that an alternative asset manager will match the operating standards and mitigate business risks in the same way as established, long-only money managers. ODD is the tool deployed by investors to ensure that alternative investment managers meet these evolving and more demanding requirements. Click here for full article
- Business Risk: An Often Neglected but Significant Source of Risk
“Never underestimate business risk,” is the lead-up cautionary advice of SwissAnalytic’s latest white paper. In “Business Risk: An Often Neglected but Significant Source of Risk,” the authors reflect on some recent news about an embezzlement case and provide other historical examples, which espouse the importance of examining business risk when researching potential alternative investments. The paper highlights areas of importance such as looking into the financial viability of the firm, staffing and compensation, the compliance function, the firm’s and its employees’ backgrounds, and asset transfer controls…to name a few. Click here for full article
- The New World of Operational Due Diligence
The current regulatory environment makes operational due diligence mandatory. Still, regulated fund structures are plagued with operational risks. Moreover, institutionalization of processes puts the onus on on–site verification rather than check–the–box.
In “The New World of Operational Due Diligence,” Swiss Analytics outlines how you can enhance your operational due diligence approach, and in turn create ‘operational alpha.’ Click here for full article
- ‘Managing’ Fees for Collective Investment Schemes
“Managing” fees requires a differentiated perspective. In times of compressed yields the public’s attention has increasingly focused on fees and other expenses. The general consensus seems to suggest that fees and expenses are generally a nuisance and ought to be avoided “at all costs.” However, it could be argued that such a point of view is short-sighted and could come at a high price. Rather, one should manage fees after a comprehensive assessment based on a differentiated perspective. Click here for full article
- Regulatory Cases: Accident Analysis of Three Regulatory Complaints
Subsequent to last fall’s white paper, Regulatory Cases Against Investment Managers: Lessons Learnt for Investors, three regulatory complaints are reviewed and discussed in more detail pointing out structures and circumstances which were instrumental in facilitating the fraud.
Furthermore, they illustrate boundaries of what can be expected from a regulatory agency suggesting that an investment advisor’s registration with a regulator is no substitute for proper, pro-active due diligence. Click here for full article
- Impact of Outsourced/Co-Sourced Due Diligence
Christian Nauer, CEO of SwissAnalytics, and his co-panelists Ruchi Nirula, Director, Asset Management, SwissRe, and Rufus Rankin, Director of Portfolio Management, Equinox Fund Management, discussed the impacts of out- or co-sourcing due diligence to an external provider at the GAIM Ops Europe 2012 conference in Paris.
Download the paper to obtain their opinion on potential problems, merits, scope and costs of contracting an external provider to conduct due diligence. Click here for full article
- Regulatory Cases Against Investment Managers: Lessons Learnt for Investors
A review of numerous high-profile regulatory cases against investment managers brought to light some recurring patterns and suggests that a handful of basic due diligence techniques would have raised questions well in time. However, equally important to raising the right questions is effectively following up and independently verifying the answers provided by the investment manager. Click here for full article
- Managed Accounts: Benefits vs. Challenges and Why Managed Account
Platforms’ Name Can Be Misleading
Separately managed accounts and managed account platforms enjoy increasing popularity among investors. While separately managed accounts have several benefits which help mitigate operational risks compared to a direct investment in an investment fund they are subject to several challenges. Managed account platforms can address some of these challenges but in some cases the term managed account platform can be misleading as some managed account platforms are more like structured products. Click here for full article
- Findings from the GAIM Ops Europe 2011
Staying current on the latest developments in operational due diligence is important for SwissAnalytics. Hence, Christian Nauer, CEO, attended and spoke at the GAIM Ops Europe 2011 conference in Geneva — a gathering of industry experts. Download the white paper to read about some of the key findings from the conference. Click here for full article
- Why Due Diligence?
Does it really pay off to conduct due diligence, after all, it is costly and time consuming and what damages could I really avoid doing it?
The potential damages are often vastly underestimated. Our experiences show, that the consequences of issues identified can be quite dire and the damages incurred turn out to be exponentially higher than the expenses of conducting proper due diligence. Over the next pages, you may find a few selective examples of issues we have found and the corresponding damages which were incurred by the investors. Furthermore, we respond to sceptical voices that do not see the value of performing proper due diligence. Click here for full article
- Trends in Alternative Investment Regulation - Key Issues for Swiss Managers
Geographically, the Swiss alternative investment market is positioned in the core of Europe. Legally, it is increasingly pressured into following European regulation, without always being invited to discuss its evolving requirements. Strategically, this unique situation poses both challenges and opportunities. In this paper we shall examine the composition of the Swiss alternative investment market, focusing on single manager hedge funds and funds of funds. In determining the trends in this market, we seek to add clarity to its structure and its evolution, hoping to dispel a myth or two along the way.
Subsequently, we will examine two core regulatory reforms which will carry significant repercussions for Swiss-based alternative investment managers over the coming years, focusing on the European Union's Alternative Investment Fund Management Directive (AIFMD) and Undertakings for Collective Investments in Transferrable Securities (UCITS).
In doing so, we will highlight several features of the increasingly politicized European funds market, and their repercussions on different types of fund-management structures. We will see that for managers to successfully navigate through this increasingly regulated and politicized, market, they are dependent not only upon their own strategic and operational positioning, but upon subsequent actions of Swiss regulator (FINMA) and of EU regulators as well. Click here for full article
- Good UCITS — Bad UCITS
What works, what doesn't, and the dangers of investor acquiescence
The UCITS III and the oncoming UCITS IV framework have included several modifications to this essentially retailinvestment regulatory framework which have caused a significant increase in interest from the alternative investment community.
Over the past several months we have analyzed several dozen UCITS-compliant absolute-return funds. In this paper, we highlight some of the core considerations and developments by comparing our results to more traditional hedge fund structures analyzed within the same framework. As all funds were analyzed through our unitary "Silver" Due Diligence framework, we are able to identify similarities and differences between these two structures which alternative investment managers and investors are currently debating.
Rather than examining the funds from a fund-management or marketing perspective, we draw on the results of our findings strictly from an investor's perspective, highlighting variations and unexpected similarities in selected risk categories in the process. In doing so, we seek an answer to the question of whether or not a move to UCITS funds will actually lead to an improvement to a portfolio's qualitative risk profile. Click here for full article
- Early Stage Silver Due Diligence —
Towards a More Robust Approach to Alternative Funds Selection
Whether institutional or private investor, a fund distributor or allocator, all individuals charged with the daunting task of fund selection are confronted with a similar problem.
We call this "falling in love" with a fund. For the pragmatist, the love story may begin with an upward-sloping line chart. For the romantic, it can be solidified in a marketing pitch spilling sexy Greeks and spattered with an enticing financial glossary.
This article takes a closer look at the problem that this phenomenon creates for fund selectors. In doing so, we also present some suggestions on how to reduce the chance of qualitatively weaker funds from becoming approved through this bias while reducing the costs of the selection process.
We close by highlighting some examples of qualitative risk factors that we cover in our Silver Due Diligence service, which can be a useful tool for clients seeking an independent, comprehensive early-stage due diligence on their target funds. Click here for full article
- The 4 Rules of Legal Document Reviews
Investors all too often assume that if they read the Offering Memorandum (OM) , then they have understood their legal relationship with the fund. Of course, the OM is the actual contract between the investor and the fund, containing the legal and economic terms of the fund-investor relationship. Any changes to the terms of the OM must be accepted by all investors.
Although the OM is often understood to be the core binding agreement, we have seen many investors overlook the Articles of Association, which are of particular importance and can contain key provisions that trump terms of the OM. The Articles define how the business of the company (i.e. the fund) is actually to be run, including key provisions on directors' responsibilities, NAV calculation, liquidity management, general meetings of the fund , procedures for winding-up the fund, and more. When examining the articles, one must ask questions such as, "What sorts of duties are assigned to directors?" and "Have they delegated any essential duties?"
Furthermore, in a Master-Feeder structure, one must request, review and thoroughly examine the legal documents of the Master fund as well. One simple, yet common mistake is to assume that because there are independent directors assigned to the feeder fund, that the Master fund is subject to the same degree of corporate governance and accords investors the same protections, where this may not be the case. For example, in the case that the Master fund is a Limited Partnership, these controls will be specifically lacking.
Click here for full article
- Hedge Funds Misrepresent Facts? Of course they do.
Recent work has shown that 1 in 5 hedge fund managers misrepresent facts during due diligence meetings (Brown, Goetzmann, Liang and Schwarz, 2009).
Investors in the alternative investment funds have come across this fact all too often. In this paper, we take a closer look at misrepresentations, including steps that we take in order to uncover the truth about managers, their funds and their history.
Regardless of how well you think you know about a fund, managers know themselves and their business better than anyone. They also recognize that investors have certain "show-stoppers" when considering an investment in their funds. There are generally 3 choices that a manager has when confronted with hard-hitting questions. These are:
1 - Tell the truth
2 - Omit some information
3 - Blatantly misrepresent facts
To the untrained eye, it can be nearly impossible to distinguish between these three general types of information. Typically, if the manager has omitted or misrepresented information, it is in relation to factors that they believe investors will tag as red flags or take serious enough to step away from the investment. Click here for full article
- Opalesque Exclusive Interview with Swiss Analytics' Director, Andrew Perry
The Evolution of Due Diligence
Opalesque Exclusive: The Evolution of Due Diligence, Part 9 - SwissAnalytics: It is impossible to properly analyze operations without solid understanding of fund strategy. Friday, December 11, 2009 Andrew Perry: Andrew Perry is a director at alternative investment risk specialists SwissAnalytics, based out of Zurich. With several decades of combined single-manager and fund of funds management experience, SwissAnalytics is now wholly dedicated to delivering superior qualitative and quantitative alternative investment research to a broad range of alternative investment allocators. Click here for full article
- Drawing the Right Conclusions: Deriving Risks from Cross-Checks and Independent Sources
Due Diligence is as much an art as it is a science. In this month's paper, we explore sources of fraud and theft risk as examples where operational risks are derived from several sources of information. In order to properly complete due diligence, professional analysts must have the experience to step into the role of an investigator as they move through their research process. Click here for full article
- The Onsite Visit's Importance to Completing Institutional-Quality Due Diligence
By now, all serious investors in alternative investment funds recognize that it is important to visit managers onsite prior to reaching any investment decisions. Making sure that you walk away from the meeting with more than a re-digested version of the marketing pitch takes preparation, experience, patience and a structured methodology. The core purpose of the Onsite Due Diligence is to verify and cross-check the information which has been collected and analyzed in advance of the meeting, particularly as it relates to a fund's operations. Additionally, managers should provide increased levels of transparency into their strategy and tf li portfolios during the visit, as many excuses for the confidentiality of information are invalid onsite. Analysts must be thorough and structured in their approach to the Onsite Due Diligence, with solid preparation and a good understanding of the manager, the fund and the strategy beforehand in order to finish off this crucial portion of the investment analysis. Failing to do so can end up not only wasting everyone's time, but leaving the investor exposed to a wide number of risks that can materialize in unexpected draw-downs or a complete loss of capital in the future. Click here for full article
- Alternative Investments through Managed Account Platforms:
Not Exactly the Holy Grail
Managed Accounts platforms have taken off in popularity recently, with numerous providers offering solutions to increase transparency and reduce fraud risk. The increased demand for transparency and the promise of reduced risks to investing through more orthodox fund structures have driven this growth. Improved technologies are heralded as allowing more efficient management of multiple accounts, and reducing costs. Investment managers who have had difficulties raising assets into their existing funds through more traditional channels have also become increasingly willing to offer managed accounts at discounted costs or with lower minimum investments. The net effect is a growing market for managed account platforms, well documented by several industry surveys and white papers produced largely by managed account operators and alternative investment advisors. Although there are indeed several advantages of managed account platforms over traditional hedge fund investment structures, they may not be the holy grail that investors are seeking to protect their alternative investment portfolios from fat tails, significant draw-downs, blow-ups, and, yes, even fraud. We have yet to come across a case of fraud committed by a managed account platform, however that is also a feasible outcome of uncontrolled shift of investments to such vehicles. Investing through managed accounts certainly does provide multiple advantages over direct fund investing, particularly in the areas of position transparency, ownership and liquidity, however it remains crucial for investors and investment advisors to examine the full range of risks which can have a negative impact on their alternative investment portfolios. In this paper, we seek to highlight some key considerations for allocators who are confronted with the question: "Should I invest through a managed account or straight into the fund?" Click here for full article
- Hedge Fund Due Diligence...More Than Just a Background Check
Performing due diligence" has become a term widely thrown around, distorted and misconceived by both investors and investment managers in the alternative investment industry. The sad truth is that not every hedge fund investor conducts it in a comprehensive manner or believes in the merits of completing each stage using a reasonably detailed and structured approach. Both of these attitudes have led to dire consequences for investors during the market downturn, leaving them frustrated with illiquid holdings and losses worse than the "worst case scenario" than the manager had communicated. It is estimated that 2,000 hedge funds have closed (~22%) their doors since the onset of the financial crisis and that as many as 2,000 more may follow suit over the next 18 months. According to BarclayHedge, 1,500 hedge funds have closed since January 1, 2009. As investors re-think their investment processes, it is important to place comprehensive, fundamental and exhaustive due diligence at the core of any investment decision in alternative asset classes. As hedge fund failures have led many investors astray, conducting comprehensive due diligence is necessary in order to properly assess the risks of alternative investments. Alternative investment due diligence is a process in which industry professionals exhaust all analytical tools available to them in order to uncover red flags, warning signals and managers' shortcomings in the area of best practices with the goal of identifying as many material risk factors as possible which can potentially lead to a significant loss of capital or illiquidity. Click here for full article
- Looks Can be Deceiving: Qualitative Hedge Fund Due Diligence vs.
Quantitative Time-Series Analysis
In this study, we have examined the benefit of performing proper qualitative due diligence instead of only relying on the quantitative time-series analysis of a fund's track record. We did so by running a comparative analysis of our comprehensive database of qualitatively and quantitatively analyzed single hedge funds. Over the years, we have analyzed several hundred hedge funds within our existing framework, of which 127 funds have been qualitatively and quantitatively monitored over different time periods. We compared the total risk assessed for each fund and strategy on the one hand using a variety of quantitative traditional and non-traditional methods of time-series analysis and, on the other hand, applying our qualitative due diligence framework, which covers organizational, operational and strategy related risks, among others. Click here for full article