Markus Federle & Frederic Berthier, Founders & Managing Directors
THE FAIRSKY GROUP
January 2010
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.
Heightened Operational Scrutiny
Investors’ heightened scrutiny in operational matters is not only a question of making better investment decisions. It is also necessary to protect fund investors from potential liability. Funds of hedge funds, pension funds, multi-family offices and other asset managers owe a duty of care to their investors to exercise diligence in the selection of fund investments. This includes an obligation to thoroughly review and assess the specific operational risk profile of a fund as well as the adequacy of the fund’s internal controls and procedures to deal with such risk. Furthermore, investors will have to carefully document their operational diligence efforts in order to be able to rebut any allegations that they did not comply with their obligations.
Advantages of Due Diligence Outsourcing
While a number of fund of funds and other larger investors are currently reinforcing their due diligence teams to cope with this elevated standard of care, an increasing number of fund investors are taking a different approach. They outsource operational due diligence to service providers to conduct an operational review on their behalf. There are some evident advantages to this approach:
