Hedge fund operational_due_diligence_corgentum_insights_transparency_usgaap


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Originally posted in the May 2012 edition of Corgentum Consulting's Operational Due Diligence Insights.

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Hedge fund operational_due_diligence_corgentum_insights_transparency_usgaap

  1. 1. Transparency versus US GAAPDuring the operational due diligence process, one of the core documents investors commonly collectand review is fund audited financial statements. Reviewing these statements can often providevaluable insights into the operational risks associated with funds under review. Investors thatconduct such reviews may however become frustrated when attempting to dig below the surface ofsuch disclosures due in part to the limited nature of information required to be contained in theaudited financial statements of funds such as hedge funds and private equity funds.A good example of this relates to fund expenses. Generally, details of fund expenses can be found inmultiple areas of a funds audited financials including the Statement of Operations, which is alsosometimes called the Income Statement, and the financial statement notes, including the financialhighlights. In reviewing the information contained on the Statement of Operations of most fundmanagers investors may often come across an expense category referred to as Other Expenses.These catch-all categories are perfectly acceptable under US GAAP, however, the notion of suchcatch-all categories is in direct odds with the goals of an investor seeking to perform operational duediligence.Operational due diligence seeks to diagnose, analyze and mitigate investors exposure to towardsoperational risk. Transparency is a key element in gathering the data to perform this analysis. Catch-all categories in financial statements do not facilitate this transparency. The goal of US GAAP, as wellas other accounting standards, is not necessarily to assist investors in performing an operationalassessment of a fund manager. Instead, standards like GAAP seek, in part, to create a uniformmethod for presenting financial statements. It is up to investors to utilize the tools afforded to themand execute their own operational assessment.Employing financial statement analysis techniques can facilitate an investors analysis of audits andcan in some instances help investors garner more information than was seemingly available at firstglance. However, as our example illustrates, financial statements should not be viewed in isolation.When presented with such catch-call categories, particularly in the area of fund expenses, investorsshould conduct further due diligence. This can be accomplished in part through discussions with thefund manager themselves in regards to what expenses are charged to the funds and an analysis ofother fund documents such as the offering memoranda which may provide further details on fundexpenses. Furthermore, comparing the ratios of fund expenses on a year-over-year basis can alsoprovide useful guidance in this regard.Investors tend to gravitate towards certain accounting standards such as US GAAP when reviewingaudited financial statements of funds. Such standards should be viewed as merely a standard tofacilitate a further analysis. While embracing the benefits of standards such as GAAP, investorsshould also be conscious of the weaknesses present in different account standards and not let thestandard itself limit the operational due diligence process.Originally posted in the February 2012 edition of Corgentum Consultings OperationalDue Diligence Insights.For More info@corgentum.comInformation Corgentum.com | Blog | Twitter FeedTel. 201-360-2430© 2011 Corgentum Consulting, LLC
  2. 2. About Corgentum Consulting:Corgentum Consulting is a specialist consulting firm which performs operational due diligencereviews of fund managers. The firm works with investors including fund of funds, pensions,endowments, banks ultra-high net-worth individuals, and family offices to conduct the industrysmost comprehensive operational due diligence reviews. Corgentums work covers all fundstrategies globally including hedge funds, private equity, real estate funds, and traditional funds.The firms sole focus on operational due diligence, veteran experience, innovative originalresearch and fundamental bottom up approach to due diligence allows Corgentum to ensurethat the firms clients avoid unnecessary operational risks. Corgentum is headquartered at 26Journal Square, Suite 1005 in Jersey City, New Jersey, 07306. Phone 201-360-2430. For moreinformation visit, www.Corgentum.com or follow us on Twitter @Corgentum© 2011 Corgentum Consulting, LLC