It is now more important than ever for diligence processes to include a company's cybersecurity awareness, processes and defenses over its information systems, products and services. Everything companies do today in support of their business is connected to their networks or their critical vendor's networks, and the continuous data flow between them. Digital assets—from intellectual property to corporate strategies and customer data-are stored on networks persistently targeted by a broad spectrum of adversaries. Every desktop, laptop, smartphone, server and router is a potential entry point for a hacker, and there can be hundreds of thousands of endpoints in a single organization.
UCITS III appears as the gold standard, strict enough to give investors comfort and flexible enough to accommodate a large number of traditional and alternative strategies. However, in the UCITS market, one size does not fit all. The UCITS framework is heterogeneous – shoehorning strategies is a threatening practice and therefore, the label does not exempt investors from performing thorough due diligence.
In light of recent market turmoil and high-profile scandals, it is vital that investors verify that their hedge fund partners' businesses and operations adhere to the highest industry standards and best practices. Now, more than ever, investors are continually exploring new and more efficient approaches to determine which funds are worthy business partners.
Hedge fund strategies in a UCITS wrapper have become very popular among investors in recent years and more so since the financial crisis. Indeed, the proposal looks appealing as it is supposed to bring onshore in a regulated framework the hedge fund benefits which were previously available offshore and only for accredited investors. Furthermore, the UCITS framework apparently provides answers to investors’ current worries concerning transparency, liquidity, asset safekeeping and risk management.
The financial crisis has revealed a number of prominent examples of funds suffering from operational shortcomings and a lack of internal controls and procedures. These incidental observations are supported by recent research, which has shown that more than 50% of hedge fund failures are caused by operational issues. Fund investors are therefore refocusing their attention on operational fund due diligence and are reassessing their due diligence procedures and standards. The recently published IOSCO best market practices for funds of hedge funds provide some guidance in this respect.
A depth gauge is a type of pressure gauge used by SCUBA divers to determine their equivalent depth in water. Divers utilise these gauges to, among other things, avoid such things as decompression sickness.
In the same way that the term due diligence does not have a universal meaning, particularly when applied to a hedge fund context, neither does the scope and comprehensiveness – the depth – of operational due diligence reviews.
The hedge fund industry has always been about reputation. It began with big names, larger-than-life characters, making outsized returns with innovative and sometimes risky strategies. Top performers have been referred to as ‘star managers’, and successful management firms have taken on almost mythical status.
In the last five years, there has been a spate of high-profile enforcement actions against hedge funds by the US Securities and Exchange Commission (“SEC” or “Commission”) as well as other federal and state regulators and even prosecutors. Indeed, the SEC cited hedge fund fraud as a justification for requiring hedge fund advisors to register with the Commission.
The due diligence process is one of the most discussed topics with respect to the burgeoning investment asset class called hedge funds.
I have helped develop an underlying hedge fund manager from less than US$10 million under management to close to US$150 million in about 18 months when our performance was only 10%+.
Due diligence is a reality check with an in-built veto, and commences after the manager selection process but before the portfolio construction.
It is not part of the manager selection process, although it may be part of a manager elimination decision.
It is most effective prior to investment and the work is usually heavily front-loaded, but a certain element is ongoing. Much of due diligence is qualitative, operational, and mechanical - it is only peripherally an investment function.
There is a sea-change occurring in the way investors are considering potential hedge fund investments. No longer are investors satisfying themselves with a rudimentary review of a fund prior to an investment. Now best practice dictates that detailed due diligence must occur prior to, and on-going monitoring must occur following, any investment. It is now recognised that the level of due diligence applied to hedge funds should be of a standard similar to that usually applied to private M&A transactions, particularly those undertaken by private equity firms. The reason why this 'sea-change' has occurred is down to a combination of macro as well as or hedge fund-specific factors.