The April luncheon was held April 22nd in New York. Thank you to Linedata Services for hosting this event.
The topics discussed were: Institutional Hedge Fund Due Diligence, Properly Managing Operational Risk –Technology’s Increased Role in Fund Management and What to Expect from Regulators in 2010.
Institutional Due Diligence-The New Checklist.
The panel started out by agreeing that investors are spending significantly more time on due diligence and that the investment process has lengthened averaging about six months in duration. Small hedge funds are being held to standards that previously only applied to larger hedge funds and investors are demanding proof that managers actually are doing what they promised to do.
The panel suggested that managers put a risk assessment process in place to review (no less than annually) their firms in an effort to spot conflicts and issues with respect to their operations. Managers need to be able to recognize issues, address them and document how they resolve the particular matter. If necessary, it was suggested that Committees be formed and/or outside persons be brought in to assist with the review.
Additional best practices suggestions were strengthening internal management, having real time risk management, automation of processes front to back and multiple prime brokers and custodians to reduce the risk to assets.
Investors performing due diligence are looking for any inconsistency between what is in the fund’s marketing and organizational documents and what they hear or see is actually occurring. As part of the due diligence process, it is not uncommon for investors to ask to meet with traders, back office and compliance personnel as well as tracing transactions from front to back.
New Operational Requirements
Investors want to know who has access to information at a firm? They want to know what are the security protocols for data transmissions? What are the disaster recovery procedures? How quickly can you recover? What are the controls on cash and cash movements? How are trades aggregated and allocated when there are multiple funds or a managed account running alongside a commingled fund? What is the manager’s valuation policy? They want to test it.
While an outside administrator is a necessity-How does the manager check the work of the administrator? Does the manager reconcile to the administrator? How often does the manager meet with their service providers? How often does the manager review the service provider’s level of service?
The greater the degree of automation the better. Stand-alone excel schedules are frowned upon. Investors want to see systems in place and controls against human error.
Remember, there are always other places to invest-investors want to be with managers that are continually upgrading their systems and controls and providing transparency on their operations.
What Can We Expect From Regulators?
Most commentators are expecting that Advisors will have to register at some level of AUM whether that is 30 million, 100 million or 150 million. While it is expected that there would be some period to ramp up, the panel recommended not waiting until the last minute to register, as there may be delays in the registration process.
For advisors that have been in business for some time, that will most likely require a scrubbing and updating of their organizational documents. While most advisors whether registered or not, have best practices in place, the biggest change is probably undergoing the required audit by the SEC.
SEC audits have become more intense and time consuming. Current areas of interest to the SEC are controls on cash, operational controls, insider trading, best execution, how analysts get their investment ideas, fund expenses, soft dollar arrangements and disclosure thereon.
SEC examination teams may have enforcement division staff mixed in in an effort to obtain greater insight on the hedge fund business. This carries a greater risk to managers that may not be aware of the mixed make up of some teams.
Advisors need to have procedures in place to maintain all of the information required by the SEC and be able to produce it in a short period of time if requested by an examiner.
- George Roeck, Executive Board Member, HFBOA
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