Operational due diligence is top concern for hedge fund investors

The survey polled investors globally representing over USD2.13trn of total assets, with a hedge fund allocation in excess of USD724bn.
 
Operational due diligence has continued to grow in importance and an overwhelming 70% of ODD teams now have explicit veto authority in the investment decision making process, which was exercised in almost 10% of manager reviews. In a further sign of the influence ODD teams now hold, 63% of investors won’t reconsider investing in a fund previously vetoed by the ODD team.
 
Further highlights of the survey include:
 
• Investors are placing greater emphasis on the depth and breadth of their ODD team – 80% of respondents have a dedicated ODD team and investors conduct an average of 50 manager reviews a year.

• Investors are increasingly focused on fund expenses – The majority of respondents have little or no tolerance for expenses such as non research related travel or employee compensation being charged to the fund. 40% accept charges such as regulatory reporting.

• Independent governance is expected – The majority of respondents prefer at least three directors on the board including two independent directors. Nearly a quarter vetoed an investment due to lack of independent governance.

• Start-up managers need to invest in people and process – Investment in human capital and proper segregation of duties were ranked as the top two operational recommendations for start-up and emerging managers.

• Managers should expect a thorough review of operations during the site visit – Almost 60% of investors observe daily operations during a typical ODD review, using a ‘trust but verify’ approach to validate what managers represent in their documentation.
 
Daniel Caplan, European Head of Global Prime Finance at Deutsche Bank, says: “Hedge Funds have seen impressive net inflows from institutional investors this year and operational due diligence teams are now a critical part of the investment decision process.”
 
Pam Kiernan, Global Head of Hedge Fund Consulting at Deutsche Bank, says:  “This survey demonstrates the critical importance of operational due diligence to hedge funds as the industry experiences an ongoing evolution. Our results show that these teams have advanced in sophistication and provide valuable insights as to how managers can prepare for the road ahead.”