Due Diligence key questions in a hedge fund strategic review

The objective is to assess the risk accurately, a due diligence approach aim to balance quantitative and qualitative factors, but the quantitative analysis as a valuable complement, not a substitute for qualitative assessment, placing emphasis on the ongoing knowledge of the hedge fund manager, his trading strategy and investment process.

Due Diligence is the process of identifying the risk factors and understand why the investment strategy earn money being the operational risk a key factor of the overall analysis.

Parts of a Due Diligence:                                                            

• Fund’s Term, structure and governance:
  1. Fund organization
  2. Ownership
  3. Structural review
  4. Regulatory registrations
  5. Outside service providers
  6. Investment management and advisors
  7. Prime Broker

• Strategy:
  1. Investment style
  2. Investment strategy
  3. General characteristics and strategy description
  4. Investment markets
  5. Investment securities
  6. Investment process and trading procedures
  7. Monitoring procedures
  8. Benchmark
  9. Competitive advantage
  10. Current portfolio position
  11. Current long/short positions
  12. Cash controls and management
  13. Source of investment ideas
  14. Trade life cycle
  15. Capacity
  16. Key members of the investment team

• Performance:
  1. List of funds and assets under management
     1. How long has the hedge fund manager been actively managing hedge funds
     2. Have the manager’s performance results been consistent over time?
     3. Are the investment strategies the same or different for each hedge fund?
  2. Drawdowns
  3. Statistical data
  4. Withdrawals
  5. Pricing

• Risk:
  1. Risk management
     1. What are the characteristics and the level of risk involved in the hedge fund manager’s strategy?
     2. What risks are managed?
     3. How is risk measured?
     4. How risk is managed?
  2. Valuation and pricing sources
  3. Cross-sectional risk assessment
  4. Position limits
  5. Market risk, credit risk, interest rate risk and currency risk
  6. Leverage
  7. Risk monitoring procedures
  8. Business continuity and disaster recovery planning
  9. Key factors into the operational risk assessment
  10. Risk Officer

 

• Administrative:
  1. Civil, criminal and regulatory actions
  2. Employer turnover
  3. Account representative

• Legal review:
  1. Type of investment
  2. Fees
  3. Lockups and redemptions
  4. Subscription amount
  5. Advisory committee

• References:
  1. Service providers
  2. Existing clients