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Hedge Fund Operational Due Diligence: What Managers Need to Know

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Eze Castle Integration recently hosted a live webinar on Hedge Fund Operational Due Diligence.

Eze Castle Integration recently hosted a live webinar on Hedge Fund Operational Due Diligence.

Published in: Economy & Finance

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  • Corgentum Consulting is a XXXX.AIS Fund Administration is a XXXX.Eze Castle Integration is a XXXX.
  • Technology to power the investment businessEze Castle delivers superior technology solutions managed by highly experienced IT professionals that minimize infrastructure risk and increase operational efficiency. Our portfolio of services addresses business requirements from launch to long-term growth. We’ll handle everything from building out your Comm. Room and setting up your Internet and phone lines to assisting you in your disaster recovery and business continuity planning. Managed Services to simplify and optimize operationsOur hosted IT solutions provide streamlined access to leading hedge fund technology and applications, simplifying operations and reducing capital expenditures. Our Eze Managed Services platform includes our virtual office and DR offerings for firms looking to reduce costs and increase flexibility.Compliance solutions that support SEC RegulationsEze Castle’s SEC-compliant archiving and data protection solutions deliver confidence to clients and investors. We’ll talk more about our Disaster Recovery, Business Continuity and Archiving solutions in this presentation.A Communications Network that enhances the Trading infrastructure Eze Castle strengthens and streamlines connectivity to trading counterparties by delivering a highly secure, redundant and available communications network to our clients. We have the ability to offer voice, Internet, FIX connectivity and market data via a single communications platform.
  • Our top 5 technology best practices when it comes to meeting investors’ due diligence requirements:Educate your investors.-Explain the designs and processes of your operations, particularly when it comes to your technology.-Technology matters today-Anticipate questions your investors may have-Be prepared with clear and concise answers-Ask your service providers for supporting info-Dedicate 20% of your presentation to educational contentAnd Remember: “People do business with people they know, like, and trust.”
  • 2. Outline your budget.-Investors want to know where management fees are being allocated-Identify costs around:-Staffing: payroll, taxes, health and benefit costs, etc.-Building and facilities: consider office expenses and lease obligation-Technology: If you don’t have an in-house IT staff, ask your IT service provider to do this-Legal and Administrator fees-One time versus recurring
  • Here we have a sample technology budget to give you an idea of the types of costs associated with an investment firm’s technology infrastructure.
  • 3. Communicate with your service providers.-Don’t be afraid to call them if you need clarification on their systems, processes, documentation, etc. -For example, ask your technology provider to create a “technology blueprint” for you.
  • A technology blueprint involves:Defining your technology requirements-High-speed, high resiliency, secure-Communications of the firm-Voice, Data, Market Vendor, Disaster recovery replication-Applications-Disaster Recovery & Business Continuity-Compliance
  • 4. Test, test, test.-Test your systems.-Especially your disaster recovery system (at least quarterly) and show the results to investors-Regular test instills confidence and opens lines of communications with investors-Demonstrates your operational excellence
  • Two essential aspects of technology that will require testing are your disaster recovery and business continuity plans.DR = BCP =
  • 5. Make operational excellence a priority.-Investors want to see that funds are serious and that they value operations and technology as vital aspects to their businesses.-Advanced planning is essential; Anticipate and prepare for change-Use operational benchmarking to assess areas for improvement-Proactively prepare operations for upcoming regulations-Document everything-Be committed to transparency
  • Transcript

    • 1. Hedge Fund Operational Due Diligence:What Managers Need to Know
      December 9, 2010
    • 2. Our Speakers
      Jason Scharfman, Managing Partner
      Corgentum Consulting
      Vinod Paul, Managing Director
      Eze Castle Integration
      Paul Chain, President
      AIS Fund Administration
    • 3. Agenda
      The Investor Perspective
      Impact of Dodd-Frank Reform on Due Diligence
      Technology Considerations for Due Diligence
      Top 5 Technology Best Practices
      Recommendations for Fund Managers
      Q&A
    • 4. Confidential – Not for distribution
      Hedge Fund Operational Due Diligence
      Presented by: Jason Scharfman, Managing Partner
      © 2010 Corgentum Consulting, LLC
      www.Corgentum.com
    • 5. What Topics Are Investors Focused On?
      5
      Confidential – Not for distribution
    • 6. What Topics Are Investors Focused On? – part 2
      6
      Confidential – Not for distribution
    • 7. Confidential – Not for distribution
      What Investors Are Looking for During Operational Due Diligence
      Documentation:
      Accurate description of practices in place
      Absence of overly broad or conflicting documentation
      Manager understanding of documentation
      Process transparency
      Forthcoming attitude to assist investor in understanding the operational practices in place
      Reasoned understanding of why certain operational choices were made
      7
    • 8. Confidential – Not for distribution
      The Impact of Dodd-Frank on Due Diligence
      Dodd-Frank is an artificial operational floor
      Institutional investors perform due diligence at a much high standard than minimum SEC requirements
      There will be heightened scrutiny of legal/compliance:
      Has a hedge fund appropriately budgeted for the increased costs of compliance associated with Dodd-Frank?
      With the increased focus on compliance has a hedge fund spoken to the appropriate service providers to ensure that quality individuals and adequate services are dedicated to the hedge fund's account?
      What changes in compliance policies and procedures has a hedge fund undertaken? How have these changes been communicated to staff?
      Has a hedge fund developed an reporting and technology infrastructure to meet new requirements?
      8
    • 9. Confidential – Not for distribution
      Hedge fund preparation for operational due diligence?
      Understand your investors goals
      Do not mistake operational due diligence for merely discussing traditional “back-office” type issues
      Be prepared to demonstrate your strengths
      Be pro-active in highlighting any operational weaknesses
      Ensure you can discuss reasons for your operational choices
      Do not be afraid to respond that you will follow up with certain type of information
      Ask for and listen to investor feedback
      Mock operational due diligence walkthrough
      9
    • 10. Confidential – Not for distribution
      On-going Investor Operational Activism
      In the post-Madoff environment investors are more likely to make their voice heard in regards to operational issues
      Many hedge funds have been forced to implement operational changes due to shifting market perceptions (i.e. – third-party administration)
      Investors will likely perform on-going operational due diligence to, in part, monitor how a hedge fund responded to feedback
      Investors appreciate hedge fund which develop a dialogue with them regarding operational issues
      10
    • 11. Why this all matters? : Less Operational Risk = More Allocations
      A shifting allocation perspective
      Traditional allocation models would not differentiate between hedge fund A and B (as long as a hedge fund was above the minimum threshold it was acceptable)
      Modern fund of hedge funds and other institutional hedge fund allocation models would allocate more to hedge fund B (less operational risk for a higher expected return)
      11
    • 12. Why this all matters? : Case Study - Multiple “Small” Issues:
      NegativeMedia
      Inefficient Legacy AdministratorStill Utilized
      ExtendedDelay inGenevaImplementation
      No OffsiteBCP/DRSite
      No InternalValuationCommittee
      “Affiliated”BoardMembers
      CCO Unawareof OutsideBusinessDirectorships
      PersonnelTurnover
      Not being reported? or Policy not enforced?
      Compensation issues?
      Lack of independent oversight?
      Lack of internal operational planning?
      Level of pre-employment screening?
      Service provider oversight?
      Input of IT into organizational planning?
      Reputational risks?
      Retention scheme issues?
      Code of Ethics
      Violations?
      Culture of compliance? / Policy revisions?
      Information security issues?
      Sufficient internalchecks and balances?
      Are different parts of theorganization connecting?
      Is the businessscalable?
      Appropriate oversightfrom senior management?
      Financial stabilityquestions?
      Elongated Due Diligence Process
      Reduced Investment
      No Investment
    • 13. Top 5 Technology Best Practices for Hedge Fund Operational Due Diligence
      Vinod Paul, Managing Director, Eze Castle Integration
    • 14. Eze Castle Integration Overview
      Eze Castle is a firm’s partner to eliminate enterprise infrastructure risk and enhance operations. We provide a foundation for investment firms at any stage of their lifecycle.
    • 15. # 1 Educate your investors.
      Explain the designs and processes of your operations, particularly when it comes to your technology.
      Technology matters today
      Anticipate questions your investors may have
      Be prepared with clear and concise answers
      Ask your service providers for supporting info
      Dedicate 20% of your presentation to educational content
    • 16. Investors want to know where management fees are being allocated
      Identify costs around:
      Staffing: payroll, taxes, health and benefit costs, etc.
      Building and facilities: consider office expenses and lease obligation
      Technology: If you don’t have an in-house IT staff, ask your IT service provider to do this
      Legal and Administrator fees
      One time versus recurring
      #2 Outline your budget.
    • 17. Sample Technology Budget
    • 18. #3 Communicate with your service providers.
      Don’t be afraid to call them if you need clarification on their systems, processes, documentation, etc.
      For example, ask your technology provider to create a “technology blueprint” for you.
    • 19. Technology Blueprint
      ISP Edge Router
      Client Site Router
      Firewall
      Desktop
      Server
      LAN
      Define your technology requirements
      High-speed, high resiliency, secure
      Communications of the firm
      Voice, Data, Market Vendor, Disaster recovery replication
      Applications
      Disaster Recovery & Business Continuity
      Compliance
    • 20. #4 Test, test, test.
      Test your systems.
      Especially your disaster recovery system (at least quarterly) and show the results to investors
      Regular test instills confidence and opens lines of communications with investors
      Demonstrates your operational excellence
    • 21. Disaster Recovery vs. Business Continuity
    • 22. #5 Make operational excellence a priority.
      Investors want to see that funds are serious and that they value operations and technology as vital aspects to their businesses.
      Advanced planning is essential; Anticipate and prepare for change
      Use operational benchmarking to assess areas for improvement
      Proactively prepare operations for upcoming regulations
      Document everything
      Be committed to transparency
    • 23. Hedge Fund Operational Due Diligence What Managers Need to Know
    • 24. AIS Fund Administration
      Paul Chain, President
      Global Sales & Marketing | Trading
       
      Quality provider   ●     Fixed Income     ●    Derivatives   ●    Daily Model
      The AIS daily model combined with our team approach results in a
      high level of responsiveness and exceptional service to our clients
      24
    • 25. What is the Driving Force Behind Operational Due Diligence Procedures?
    • 26. Impetus for change
      Bayou Group - $450M
      KL Financial - $81M
      Amaranth Advisors – $6.4B
      Petters Group Worldwide - $3.5M
      Stanford Financial Group - $8B
      Beacon Hill Asset Management – $400M
      Lipper Convertible - $350M
      Madoff – $64.8B
      26
    • 27. 27
      Evolution of Due Diligence
      Due Diligence Officer is no longer a Junior Person
      Industry standard, not a hobby
      Process is still evolving, not where it should be
      Investors need to be educated
    • 28. Changing Position of Investor
      Paradigm shift
      Managers and Administrators can help
      Big vs. small allocators
      Tick the box vs. sophisticated investor
      Education and advice
      Watch lists
      Know Your Customer
      28
    • 29. Actionable Due Diligence Recommendations
      Process is evolving, need to adapt with it
      Ask questions
      What is their view of due diligence process
      What is important to them
      What is their background
      Don’t make assumptions on what they know/don’t know about process
      You’ll be in a position to learn or educate – which is it?
      If they want to tick the box, help tick the box
      If they want to understand the process, help them understand
      Before meeting ends, make sure you’ve communicated your views on process
      Meet the needs of your customer
      29
    • 30. Eze Castle Integration Overview
    • 31. Tel: 800.752.1382 www.eci.com