Operational Due Diligence Investment Managers


Initial Assessment Of The Target Company Operations

Operational Due Diligence Monitoring Solutions
  • how well do the operations of the target company fit with those of the buyer?
  • What synergies/conflicts exist between the buyer and the target company?
  • Are there any âquick winsâ that can generate value?
  • What kind of investment will be required to bring the target company operations to the desired level?
  • How sustainable are the operations?
  • Portfolio Leverage And Portfolio Liquidity

    Here, the investor analyzes the present and the past data in leverage to track changes, find out the sources of leverage as well as the portfolios liquidity. From these evaluations, the investor can locate the degree of illiquidity and leverage that can cause the strategys returns to diverge from the expectation.

    It is worth noting that different strategies have different extents of liquidity and leverage. Therefore, the investor must adjust their expected returns from one plan to another.

    Choosing An Odd Provider

    Investors may perform operational due diligence themselves or they may work with consultants to either outsource operational due diligence reviews entirely, or to complement their own internal efforts. The general consensus is that the forms of ODD which provide greatest benefit for investors are those characterised by:

    not relying on a checklist approach so that the investigation is bespoke for the investor’s specific interests and tailored to the target alternative investment fund

    offering multi-disciplinary solutions to legal, financial and accounting, tax, regulatory and compliance, risk management, corporate governance and internal control concerns

    the involvement of a team with the breadth and depth of experience to clearly and succinctly identify red flags and propose practical recommendations for risk mitigation and monitoring

    transparency of detailed findings to the end investor note that managers of funds of alternative investment funds typically do not provide full transparency to their investors of the findings of their ODD, with investors simply becoming aware, after the fact, that an investment in an underlying fund has been made or that a divestment has occurred

    succinct written responsibilities and scope, as well as clear legal liability of those performing the ODD for the quality of their work

    being paid for directly by the end user rather than by the alternative investment fund or its manager or bundled as part of a wider service .

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    Back To Basics: The Value Of Operational Due Diligence

    Due diligence has evolved significantly in recent years, transitioning from a specialist consulting discipline, focused only on hedge funds, towards an institutional, fintech enabled risk management tool.

    As the scope of due diligence has expanded, it is perhaps helpful to revisit the basic question why complete ODD in the first place?

    Castle Hall has identified four factors which demonstrate the value of an effective, systematic due diligence process. ODD adds value both when onboarding new asset managers, and when monitoring operational risks across the current, invested portfolio.


    The nightmare scenario for any investor is to allocate to a manager which is subject to fraud: there will always be investment managers who steal cash from their funds, manipulate valuations or cheat around compliance controls.

    Even in the absence of direct dishonesty, any asset manager can make an honest mistake. Effective controls and procedures, commensurate with the size and complexity of a managers firm and strategy, reduce the risk of errors such as fat finger trading, reconciliation mistakes, or problems with trade allocations between funds.

    Has the asset owner completed sufficient diligence to veto a proposed allocation to a manager with an elevated risk of operational failure?




    What Is Operational Due Diligence

    Hedge Fund Operational Due Diligence Master Class ...

    Operational due diligence is the investigative analysis conducted by a buyer of the operations of a target business. In the broadest terms, the operations of the business consist of how the business turns inputs into outputs. The role of operational due diligence is to assess this process and its future sustainability for the buyer in an M& A transaction.

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    Operational Due Diligence On Long

    Long-only strategies or traditional asset classes are considered less risky, so consequently, long-only asset managers do not need to be subjected to in-depth operational due diligence or is it really so?

    Such an opinion was common prior to events in the industry that proved it wrong and reminded investors that less risky doesnt mean there is no risk.

    Which Areas Should Operational Due Diligence Cover

    Despite fundamental differences in their sizes and strategies, different investment managers are exposed to similar operational issues.

    Thus, every thorough operational due diligence should review the managers commitment to regulations and industry best practice standards in relation to legal structures and documentation, service providers, personnel, risk management, IT and compliance.

    The initial operational due diligence typically involves four main stages: documentation or desk review, onsite visit, service provider review and background checks.

    The key areas that every operational due diligence should cover are:

    Operational due diligence questions can be a part of a due diligence questionnaire or can be created as a specific questionnaire, focusing on operational aspects.

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    Risk Management: Operational Due Diligence

    Managers approved for SEIs strategies have an arms-length relationship with the assets they are expected to manage, which helps shield investor assets from misuse.

    • Operational due diligence focuses on whether investment managers can accommodate both regulatory mandates and SEIs requirements.
    • There are many practical implications in determining if a managers business is sustainable and compliant with relevant regulations.
    • Managers approved for SEIs strategies have an arms-length relationship with the assets they are expected to manage, which helps shield investor assets from misuse.

    SEIs Manager Research team seeks to determine how third-party investment managers will execute strategies on our behalf. This is accomplished through a combination of what the managers tell us about their philosophies and processes and what we can observe about their practices. We judge how their philosophies and processes align with our risk and performance expectations in a given environment.

    Like our Risk Management team, Operational Due Diligence is focused more-or-less exclusively on gauging risk exposure. The venue for observing those risks is outside of our security risk-factor model, however, and inside the investment managers business.

    On The Record: How Do You Do Operational Due Diligence

    Webinar: Demystifying Operational Due Diligence- Due For A Change?

    By Susanna RustJuly / August 2017

    On-site visits becoming more important

    The importance of operational due diligence has increased vastly. We carry out ODD checks on up to 20 managers a year. Our investment team commissions the business assurance team to start the ODD process on a new manager. I dont have the right to veto a decision by the investment team but I have a reporting line to the CEO and trustee. I have not yet had to use this.

    The approach to ODD depends on the asset class. If it is something esoteric or the manager is US-based we might outsource.

    If we are doing ODD in-house we start with a questionnaire, which deals with topics such as governance, compliance, and controls and oversights in the investment process. While the managers are completing this, we do some desktop checks, using LexisNexis, which collects any publicly available information on the company, and regulatory checks. We might also analyse managers accounts.

    On-site visits are becoming important, as more managers tend not to share information electronically. We ask for dedicated time to read documentation on-site, without the managers representation there.

    I am also a member of an ODD forum for institutional investors, where pension funds share experiences and thoughts on how to develop an industry standard, for example on questionnaires. A collective approach would raise the bar.

    Rejecting managers on ODD grounds

    Risk management proof wanted

    Interviews by Susanna Rust

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    Odd And Odd Iq Service Levels

    You can pair ODD IQ with full-service ORSA ODD assessments by experienced due diligence professionals, including independent qualifications, interviews, documentation and analysis. We offer three levels of service:

    • ODD IQ Our lowest priced offering is designed for groups with internal expertise and provides automated critical exposure reporting
    • ODD IQ Plus This service level provides the reporting of ODD IQ plus an ORSA consultants expertise for those who need additional expertise to develop risk management strategies
    • Full ODD Comprehensive, traditional operational due diligence that incorporates ODD IQ reporting and our independent qualitative assessment of an expanded range of potential risk factors

    Contact Us

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    What Does A Good Diligence Process Consist Of

    A good diligence process includes a review of manager documents and policies to gain an understanding of operations, valuation policy, lifecycle of a trade, IT infrastructure and compliance. Once the ODD team understands the basic operating setup, it should conduct meetings with key personnel including the chief financial officer , chief compliance officer , chief operating officer and head of trading to determine the institutional quality of operations. The objective of these meetings is to ensure implementation of written policies, adequate internal controls and proper segregation of duties.

    The ODD team should study changes in assets under management, capital commitments, the ownership structure, key hires and departures, compensation structures, strategic plans and other material issues.

    Operational Due Diligence On Private Equity

    Asian Wealth Management and Asian Private Banking ...

    Investors are increasingly performing operational due diligence reviews on other types of alternative investments, including private equity funds.

    A 2012 book by Jason Scharfman of Corgentum Consulting titled, Private Equity Operational Due Diligence: Tools to Evaluate Liquidity, Valuation and Documentation is focusedon techniques for performing operational due diligence reviews of private equity funds.

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    What Your Peers Are Reading

    However, Ronald Reagans old adage, trust but verify, is a fundamental tenet of operational due diligence. As such, to verify information and responses provided by a third-party manager, an investment adviser must utilize other tools. Online searches of a third-party managers website and social media pages, the review of its Form ADV on the Investment Adviser Public Disclosure website, and Google searches can reveal a great deal about a manager and even provide background information used to customize the due diligence questionnaire.

    Increasingly, onsite visits of a manager are becoming more prevalent because some managers will only allow for certain sensitive information to be reviewed onsite. However, onsite visits also allow an advisor to interview the managers employees and to observe a managers operational processes and risk management systems at work. Some advisors will ask to speak with a third-party managers service providers, such as custodians, auditors and fund administrators. These tools are designed not only to gather information about a manager, but also to ensure that such information is consistent with what the manager is saying.

    Sample Questions For Operational Due Diligence Questionnaire

    Questions about risks and compliance management

    Does the manager have a compliance manual, how comprehensive it is and when was it last updated? Does the manager employs a dedicated and qualified Chief Compliance Officer, or relies on a third-party consultant? How do policies and procedures that address key compliance topics look like? Determine regulatory registrations for the manager.

    Questions examining the manager´s financial stability

    What bank account is an investors subscription cash sent to and who controls these accounts administratively? Who can change the two sign-off control configurations in the prime brokers online payments system does the prime broker control this, or can an employee of the manager make changes to the requirements? In the case of a payment of expenses from the master and/or feeder funds, are all expenses reviewed against payments made from the funds to further protect against fraud? Which controls exist on the movement of cash into any direct or indirect subsidiaries of the master fund, or any affiliated vehicles processing payments going to the master fund.

    Questions inspecting the manager´s IT infrastructure and security

    Questions about the manager´s operations and trading procedures

    Questions inspecting the manager´s staffing

    Questions about service providers

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    Increased Compliance Focus During Operational Due Diligence Reviews

    Operational due diligence reviews performed by ODD analysts and investors have increasingly devoted significant portions of the overall reviews towards compliance related matters. A 2017 book by Jason Scharfman of Corgentum Consulting titled, Hedge Fund Compliance: Risks, Regulation, and Management outlines that the reasons for this include the increased complexity and volume of global compliance regulations relating to alternative investments. It has also been suggested that this trend will continue as changes in established regulations, such as Dodd-Frank, are being considered in the U.S.

    A 2018 companion book by the same author titled, Private Equity Compliance: Analyzing Conflicts, Fees, and Risks, provides evidence that the trend of having operational due diligence not just only incorporate, but also more heavily focus on compliance, has continued to expand in the alternative investment space to go beyond hedge funds into private equity.

    Comparison To Operational Risk Considerations In The Context Of Banks’ Prudential Capital Requirements

    Private Equity Operational Due Diligence

    Much of the literature associated with ODD, particularly the academic literature, is based on an underlying definition of operational risk that was originally designed in the context of the banking industry and contained within the Basel Accords, which holds that operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events.

    The banking industry is, in most economies, subject to regulation by a national financial services supervisory body, for example the Financial Services Authority in the UK, with the regulatory regime including a requirement for banks to hold at least minimum levels of capital designed to withstand the likely incidence of various risks, including operational risks. The capital held by banks for the purpose of meeting the requirements of the relevant regulator is referred to as their capital requirement or prudential capital.

    The imperative of considering operational risk in the context of banks is to ascertain an amount in currency which, if maintained by the bank as capital, should fully compensate for the expected impact of crystallization of the operational risks faced by the bank. When this operational risk requirement is added to the other elements of a bank’s prudential capital requirement , the resulting total gives the bank’s total capital requirement.

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    Sbai Publishes Guide To Operational Due Diligence Of Crypto Assets

    SBAI, a global alliance of alternative investment managers and allocators and custodian of the Alternative Investments Standards, has released a new Toolbox memo providing guidance on completing operational due diligence on crypto assets. The memo can be found in the SBAI Toolbox for Crypto Assets.

    Crypto assets were once the purview of retail investors, but more recently the asset class has gained attention from institutional allocators and alternative asset managers. There are dedicated crypto funds specialising in digital assets, however some more traditional hedge fund managers are now allocating to this asset class.

    Institutional allocators conduct operational due diligence on the underlying managers and funds that they invest in, including on elements such as counterparties, valuation, and conflicts of interest. Crypto assets operate using different infrastructure than more traditional asset classes, therefore any ODD must take account of certain risks that are more prominent within this asset class.

    This toolkit was produced with input from both allocators and asset managers. The SBAI community is made up of over 150 asset managers representing over USD2 trillion in AUM and over 90 institutional investors overseeing USD4 trillion in assets.

    Why Is Operational Due Diligence Used More With Hedge Funds And Private Equity Managers

    The term of operational due diligence has been more mentioned in reference to alternative investments, especially hedge funds, and private equity. The reason why investors put more effort into ODD for these types of managers can be explained by the fact that they are less regulated, compared to, for example, mutual funds. Both, hedge fund managers and private equity managers involve operational risks such as cash management, valuation, IT security, and the most feared increased possibility of fraud.

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    Laven Mitigates Risk Through A Thorough And Process Driven Approach

    Each review assesses the asset manager and the funds commitment to regulations and industry best practice standards. Through the use of proprietary software, Lavens reports offer consistency across asset classes. An integrated scoring system per chapter and overall report give clients a benchmark from which to compare managers. Following an instruction to perform ODD on a fund, we take the following steps:

    Be Prepared To Go Virtual

    Investment Operational Due Diligence

    The COVID-19 pandemic has changed the way many organizations conduct business, including investors. A recent study from the Investment Management Due Diligence Association found that 29% of investment due diligence officers no longer carry out reviews in person. Digitalizing documents and creating a shared agenda may help the review proceed smoothly for all parties. Virtual Data Rooms have become increasingly popular as they securely store documents and allow multiple users to access the documents simultaneously. In addition, internal parties should plan to take the meeting via video to improve communication quality.

    Under traditional ODD methods, coordinating meetings and travel is standard practice. A remote process can be more cost-effective and gives investors more opportunities to conduct a detailed and comprehensive review. Whereas an in-person review may be just a one-day onsite meeting, remote ODD allows for multiple sessions and interviews over the course of several days.

    With more investors carrying out ODD before they cut a check, fund managers should invest the time and resources into providing a solid response to investor requests. This begins with preparation and ensuring that all firm employees are aligned on what is required to ensure the firm passes ODD requests with flying colors.

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