Top 10: Due Diligence Guide for Hedge Fund Managers

Hedge Fund Operational Due Diligence

Hedge fund due diligence is at forefront for investors and managers alike– Inquiries are increasing

Lack of transparency no longer acceptable– Competition for investments is high

Operational excellence is becoming top factor in allocation decisionsOur Top 10 list was developed in-coordination with leading hedge fund professionals.

#1 Know your investors & Build rapport.

Understand what their goals are. If you don’t know what they are, ask them!Remember it’s not about you – aim to form a long-term partnership

# 2 Educate your investors.

Explain the designs and processes of your operations, particularly when it comes to your technology.Anticipate questions your investors may have– Be prepared with clear and concise answers

Dedicate 20% of your presentation to educational content

And Remember: “People do business with people they know, like, and trust.”

Investors want to know where management fees are being allocatedIdentify costs around:– Staffing: payroll, taxes, health and benefit costs, etc.– Building and facilities: consider office expenses and

lease obligation– Technology: If you don’t have an in-house IT staff, ask

your IT service provider to do this– Legal and Administrator fees– One time versus reoccuring

# 3 Outline your budget.

#4 Document everything.

Written results are the best way to impress investors.Clear documentation on:– Partnership/operating agreement– Private placement memorandum– Subscription agreement– Allocations– Distributions, redemptions and transfers

#5 Be transparent.

You will score points with investors if you are up front about everything and don’t attempt to hide anything.What transparency means…– 100% see-through of research, decision-making

process and investing– Regular risk reporting

• Proactively send to investors (monthly, quarterly)• Investors will judge on how fast you can provide these reports

– Thorough hiring process; Highlight pedigree of talent

#6 Complete a DDQ.

A due diligence questionnaire is a great exercise for funds to complete. You can also compile a comprehensive presentation or simply have an open question and answer session with your potential investors.Use the Managed Funds Association’s DDQ to prepare and identify the questions investors may ask: Download it Here.

#7 Try a mock due diligence review.

Hire a consultant to help you with this – it is the single easiest way to prepare for a real investor review.There is a lot to cover:

– Fund Service Providers – Regulatory Registration – Google Search – Risk Factors – Risk Control – Operation – Valuation – Administration – Site Visit

– Due Diligence Preparation – Fund Snapshot – Investment Strategy – Historical Returns & Stats – Assets Under Management – Audited Financial Statements – Personnel – Fund Terms – Fund Details

#8 Communicate with your service providers.

Don’t be afraid to call them if you need clarification on their systems, processes, documentation, etc. – For example, ask your technology provider to create a

“technology blueprint” for you.

#9 Test, test, test.

Test your systems.– Especially your disaster recovery system (at least

quarterly) and show the results to investors

Regular test instills confidence and opens lines of communications with investorsDemonstrates your operational excellence

#10 Make operational excellence a priority.

Investors want to see that funds are serious and that they value operations and technology as vital aspects to their businesses.Advanced planning is essential; Anticipate and prepare for change– Use operational benchmarking to assess areas for

improvement– Proactively prepare operations for upcoming

regulations

What’s Next for Due Diligence?

It’s an ongoing process that must continue to improve and evolveUnderstand where the real risks reside and work to resolve – instill confidence with investorsEducate your personnel and be transparentInvest in operations and technology that keep you functional and efficientLastly, COMMUNICATE with investors openly and honestly

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