Hedge fund operational_due_diligence_corgentum_insights_private_equity_investor_approaches

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

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Hedge fund operational_due_diligence_corgentum_insights_private_equity_investor_approaches

  1. 1. Private Equity Investor ApproachesOnce an investor begins developing an operational due diligence program, there is a likely tendencyover time for the nature of fund manager reviews to change over time. This could be in part due tochanges in the market environment in which fund managers operate. An example of this would beregulatory changes such as changes in SEC registration requirements. Such changes would affectthe nature of a fund managers operational risk environment and therefore, investors would need totailor their operational due diligence programs accordingly. The nature of operational due diligencereviews can also change among different fund managers within the same asset class. For example,an investor might be required to perform a different type of operational due diligence review on thevaluation practices of a long/short equity fund manager as compared to a distressed manager.Similarly, operational due diligence techniques may also vary among asset classes. This isparticularly true in comparing operational due diligence approaches to hedge fund and private equityfunds.When investors begin the operational due diligence process, they may develop a core processaround a certain asset class. In recent years, many investors developed their operational duediligence programs around hedge funds. The logic behind this may have been that many investorsmay have viewed hedge funds to be the riskiest parts of their overall investments, at least from anoperational risk perspective. Over time, more and more investors have begun to realize the benefitsof a well-developed operational due diligence program which reviews operational risk across fundmanagers from all asset types including hedge funds, private equity and long only managers.Focusing on private equity in particular, there are a number of different operational due diligenceapproach commonalities and differences between hedge funds and private equity. Some commonsimilarities between hedge fund and private equity operational due diligence include the sharedprocess goals of evaluating operational risk. Additionally, among hedge funds and private equityoperational due diligence approaches for most investors, there will also likely be an overlap in coreoperational risk areas reviewed such as valuation, technology, regulatory and complianceIt is also worth considering the ways in which the underlying fund managers themselves are differentfrom an operations perspective. As compared to their hedge fund counterparts traditionally, privateequity managers trade less frequently than hedge funds. Investors may dangerously equate lesstrading frequency with less operational risk.While increased trading frequency may increase the time span over which a trading problem mayoccur, this does not necessarily decrease the magnitude of potential losses. Operational problems inprivate equity firms may result in trading losses which are more consolidated and may still lead toequal or greater losses, as compared to more frequently traded hedge funds. As such investorswhich initially developed an operational due diligence program centered around hedge fundinvestments, one must not ignore operational risks relating to trade operations when applying thiscore program to private equity.Other key traditional differences between hedge fund and privateequity funds that investors might want to consider in tailoring their operational due diligenceprograms include:  Private equity portfolios may be more concentrated as compared to hedge funds  After initial fund raising, many private equity funds generally do not have as actively traded portfolios as hedge funds  Beyond certain core documents, hedge funds and private equity funds will generally have different series of documents which an investor will need to collect and review during the operational due diligence process
  2. 2.  Investors may need more asset specific knowledge to effectively perform operational due diligence on certain private equity fundsDue to these differences, investors should consider the benefits of not employing one singleapproach towards operational due diligence which lumps together all asset classes and fundmanagers. Instead, investors should take measures to adapt their hedge fund operational duediligence programs appropriate so as to ensure the key operational risks associated with privateequity funds are appropriately vetted. The results will be better tailored operational risk reviewswhich afford investors with the opportunity to drill down on operational risks specific to each assetclass.Originally posted in the February 2012 edition of Corgentum Consultings Operational DueDiligence Insights.For More info@corgentum.comInformation Corgentum.com | Blog | Twitter Feed Tel. 201-360-2430About 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 fund strategiesglobally including hedge funds, private equity, real estate funds, and traditional funds. The firms solefocus on operational due diligence, veteran experience, innovative original research andfundamental bottom up approach to due diligence allows Corgentum to ensure that the firms clientsavoid unnecessary operational risks. Corgentum is headquartered at 26 Journal Square, Suite 1005in Jersey City, New Jersey, 07306. Phone 201-360-2430. For more information visit,www.Corgentum.com or follow us on Twitter @Corgentum.

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