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Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
Top 10 List for Mastering Operational Due Diligence
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Top 10 List for Mastering Operational Due Diligence

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Presentation by Stone House Consulting at the 2nd Annual Hedge Fund Operations and Technology Conference in April 2009.

Presentation by Stone House Consulting at the 2nd Annual Hedge Fund Operations and Technology Conference in April 2009.

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  • Escalation procedures – people don’t do their jobsPart of what they are assessing is risk awareness and attitudes toward riskWhat are you doing differently in the wake of Madoff, Lehman, Stanford, Bear, etc.?
  • Conflicts – examples – personal trading, giftsWas Bernie Madoff’s auditor REALLY independent?Consider registration – and behave like you areAppropriate discipline for violations, especially compliance
  • Obtain written representation from investors that they understand the risks of investing in the fund:Receipt and understanding of the PPM and organizational documentsHave the understanding and knowledge to evaluate the merits and risks of their investment and can bear such risksUnderstand the terms of investment including minimums, withdrawals rights, liquidity provisions, allocation, fee structure, etc.Pricing If new instruments purchased that require additional methodologies, develop new policies at the time of purchase Multiple sources of prices for non-exchange-traded instruments
  • Adequate #s Based on volumes, level of automation, need to segregateSegregation of duties:Trade settlement is handled by non-investment staffIdeally, trade settlement is not handled by reconciliation or fund accounting staff eitherTrade confirmations sent directly to trade settlement staff – not investment teams 2 staff for wires (do electronically) AND free deliveries Pricing staff should not report into investment teams
  • With which legal entity have you contracted?Who are the sub-custodians?Note that changing auditors, etc. can raise red flagsDue diligence should include:CreditworthinessTheir procedures, policies, staffing, consistency, DD on THEIR vendorsPeriodic review of AML practices by third-party providers where appropriate
  • Who should be there?Ideally, one person is there all day (salesperson)Identify possible points where conflicting info might be providedEnsure day remains on schedulePose questions to subsequent participants or backdrop on what was coveredCoordinate follow-upPre-screen follow-upThey will want to meet staff – at least handshakesEnsure someone is still managing the money Assess skills of internal people to meet prospects and clients (should be part of your hiring process)Knowledge and backgroundJob functionAbility to stay ‘on message’Ability to avoid saying or doing something stupidPeople skillsPolishWell spokenAppearance/dressTable mannersFeed them – but not lavishly!Time for breaksPossible tourBe careful about leaving papers aroundGreat opportunity to have new staff learn about the firmConsider a signed NDA before too much is revealedMake sure your processes and procedures are clear and consistently appliedAnd review them regularly – with updates as necessaryMinimum annual reviewReview when errors occur – to keep from happening againReview then others’ errors are announced in the marketplaceReview when you launch new products, systems, etc.Review when you change staffing levels – up or down
  • Transcript

    • 1. Top 10 Listfor MasteringOperational Due Diligence
      2nd Annual Hedge Fund Operations and Technology Conference
      21 April 2009
      Holly H. Miller, Partner
      Stone House Consulting, LLC
      21 April 2009
      1
      © 2009 Stone House Consulting, LLC
    • 2. Interesting Points
      Operational risk is defined as ‘risk without reward’
      More than 50% of hedge fund failures relate to operational risks with a primary contributor being a basic lack of segregation of accounting roles between the front office and the back office1
      The administrators represent as many potential problems as the hedge funds
      21 April 2009
      2
      …and this slide was prepared BEFORE the Madoff scandal!
      1 Data based on a March 2003 study by Christopher Kundro and Stuart Feffer with Capco (www.capco.com). The study is based on 100 hedge fund failures over the past 20 years.
      © 2009 Stone House Consulting, LLC
    • 3. A Word of Advice
      Prepare!
      Lists
      Counterparties with ISDAs,
      Service providers
      Vendors
      Systems
      Organization charts
      Workflows
      PPMs
      Agenda
      Make sure you are on the same page
      Agree who talks about what
      21 April 2009
      3
      © 2009 Stone House Consulting, LLC
    • 4. #1 – Plan for the Worst
      Disaster
      Fraud
      Staff loss
      Unfavorable markets
      Regulatory changes
      Counterparty failure
      Prime broker failure
      Escalation procedures
      Think about all the things that can go wrong – and talk about them
      21 April 2009
      4
      © 2009 Stone House Consulting, LLC
    • 5. #2 – Independent Oversight
      Independent review of:
      Investment management activity
      Investment guideline compliance
      Adherence to discipline
      Execution quality
      Risk monitoring
      Pricing
      Conflicts
      Independent fund administrator
      Independent auditor
      Periodic internal review – and testing – of processes
      Formal committees
      Pricing
      Best execution
      Conflict
      Investment review
      Risk
      21 April 2009
      5
      © 2009 Stone House Consulting, LLC
    • 6. #3 - Document
      Processes and policies - including escalation procedures (and review these periodically)
      Compliance
      Risk monitoring
      Subscription / redemption (including KYC, AML and Patriot Act)
      Trading (including orders and executions)
      Settlement
      Cash movements and securities delivery (including margin and collateral)
      Reconciliation (including all collateral)
      Corporate action monitoring
      Month-end closing
      Pricing
      Fund accounting (including review of external administrator work)
      Counterparty selection and approval
      21 April 2009
      6
      © 2009 Stone House Consulting, LLC
    • 7. #3 – Document (continued)
      Service level agreements
      Internal
      External
      Events
      Orders, trades and confirmations
      Reconciliation (including review)
      Pricing (what was obtained and from whom)
      Fund accounting (review of external administrator work)
      Investment and research meetings
      Committee meetings (e.g. minutes)
      Trade errors
      21 April 2009
      7
      © 2009 Stone House Consulting, LLC
    • 8. #4 – Staff Appropriately
      Adequate headcount
      Including operations, accounting, compliance and IT
      Knowledge, skills and experience
      Complex strategies require additional expertise
      Training
      Cross training
      Understand best practices
      Supervisory qualifications
      Segregation of duties
      Clearly identified CCO and CRO
      21 April 2009
      8
      © 2009 Stone House Consulting, LLC
    • 9. #5 – Discipline and Consistency
      Discipline with a repeatable process – and make sure your stats back that up!
      Buy and sell disciplines
      Investment guidelines
      Consistent pricing process
      Consistent trade allocation policy
      21 April 2009
      9
      © 2009 Stone House Consulting, LLC
    • 10. #6 - Ensure a Level Playing Field
      Provide all investors with a consistent level of information
      If additional transparency is provided to one investor, managers should be willing to offer it to all investors upon request
      21 April 2009
      10
      © 2009 Stone House Consulting, LLC
    • 11. #7 – Disclose
      Changes to valuation policies
      Key personnel changes
      Service provider changes
      Changes to biographical or disciplinary information regarding the firm or key staff
      New side letters or parallel managed accounts that grant terms to certain investors that could, in certain circumstances, adversely impact other investors,
      Occurrence of operational issues that could impact the fund
      Discovery of fraud or wrongdoing within the firm or by a key service provider
      When in doubt...
      21 April 2009
      11
      © 2009 Stone House Consulting, LLC
    • 12. #8 – Due Diligence
      • On investments
      Not just for fund-of-fund managers
      • On key service providers
      Prime brokers
      Custodians
      Fund administrators
      Auditors
      IT vendors
      Counterparties
      Others
      • Service provider due diligence should include (at a minimum):
      On-site visits
      Initial and annual follow-up
      Documentation of due diligence performed
      21 April 2009
      12
      © 2009 Stone House Consulting, LLC
    • 13. #9 – Shadow Records
      Investment accounting
      Partnership accounting
      Features:
      Full audit trail
      Automated maturity, expiration, income, withholding and reclaim processing
      User security based on roles
      Backups
      Record retention
      GIPS® compliance and verification
      21 April 2009
      13
      © 2009 Stone House Consulting, LLC
    • 14. #10 - Metrics
      Quantify, measure and monitor material risks taken by the fund on a frequency appropriate to the fund’s characteristics
      Risk monitoring should be appropriate to the fund’s strategy, investments and characteristics
      Recognize relationships and risk factors may change over time, so review the process regularly
      Non-quantifiable or measurable risks should still be monitored
      Business volumes, cost drivers and stress ratios, e.g.
      Trades
      Wires
      Subscriptions / redemptions
      Accounts / funds
      Investors
      Fail rates
      Match rates
      Staff
      21 April 2009
      14
      © 2009 Stone House Consulting, LLC
    • 15. Two Last Pieces of Advice
      Practice what you preach
      Be honest
      21 April 2009
      15
      © 2009 Stone House Consulting, LLC
    • 16. About Stone House Consulting
      Strategic, operational and IT consulting for investment managers and hedge funds
      Breadth of knowledge. We have proven, hands-on experience across all instrument types and all investment vehicles, including institutional separate accounts, mutual funds, hedge funds, private equity funds and SMA (‘wrap’) accounts.
      First-hand experience. We have worked as consultants – and we have worked on the buy side. We understand the competing demands, requirements, deadlines and priorities that our clients face every day. And we have seen the pitfalls first hand.
      The Cornerstone program. Our flagship program, Cornerstone, is designed to ensure asset managers reduce their costs by 10-30% within a year.
      21 April 2009
      16
      © 2009 Stone House Consulting, LLC
    • 17. Holly H. Miller
      Holly H. Miller is a partner at Stone House Consulting, LLC, providing strategic, operational and IT consulting services to investment managers and hedge funds. Prior to founding Stone House Consulting, she was Chief Operating Officer at M.D. Sass Investors Services, managing $15 billion in hedge funds, private equity funds, traditional separate accounts and SMA (‘wrap’) accounts across 18 investment strategies and 15 investment management firms, including Waterfall Asset Management, Resurgence Asset Management, Re/Enterprise Asset Management, Crow Point Partners, Arcadia Asset Management, Ascent Real Estate Partners, Denahi Global Investments, Taurus Funds Management, Three Kingdoms Capital and M.D. Sass-Macquarie Financial Strategies. During her 30-year career, Ms. Miller was East Coast Region Manager for Citisoft, Inc. where her clients included Nuveen Investments, Dimensional Fund Advisors, Lord Abbett, T. Rowe Price and DuPont Capital Management. She has also managed operations teams for Bank Julius Baer, J.&W. Seligman and Citigroup.
      Ms. Miller’s understanding of all aspects of the investment management and hedge fund business from investment decision-making to sales and marketing to trade settlement to performance measurement, coupled with her seasoned project management skills, result in a powerful ability to assist clients with long-term strategic planning, evaluating outsourcing, streamlining operational processes, selecting and implementing systems, cutting costs and reducing risk.
      21 April 2009
      17
      © 2009 Stone House Consulting, LLC
    • 18. Contact Details
      Holly H. Miller
      Partner
      +1 610 358 1791 phone
      +1 917 587 2411 cell
      +1 509 479 1831 fax
      hmiller@stonehouseconsulting.com
      Stone House Consulting, LLC
      Strategic, operational and IT consulting for investment managers and hedge funds
      www.stonehouseconsulting.com
      New York | Philadelphia | Wilmington
      18
      21 April 2009
      © 2009 Stone House Consulting, LLC

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