Due Diligence on Hedge Funds
Conducting Due Diligence on Hedge Funds
(HedgeFundBlogger.com) No set of rules can guarantee that you do not end up with a mini-Madoff at some point, but learning about best practices in the industry, working with institutional consultants, and working with a qualified wealth manager or family office can greatly reduce the chances. There is a small blog I sometimes read written private equity and hedge fund investors. Recently they have been discussing fraud in the industry and the rules they follow to avoid such groups. Below is part of an article released this weekend on what to do while looking at a hedge fund investment:
1. Rule number 1, never invest in a manager solely on a referral without doing some basic homework NO MATTER HOW MUCH YOU TRUST OR RESPECT THE REFERRAL PERSON– the follow monthly should take less then an hour total and a monthly follow up less then 30 minutes per month.
2. Rule number 2, Meet your prospective manager at his office and get a complete review of his strategy – take reasonable notes and ask at least the following questions:
a. How do you make money? What makes your strategy special or different from other strategies? How much leverage do you use and how important is leverage to your strategy (remember leverage isn’t a bad thing if the exposure to the leverage as a function of time is small relative to the leverage)
b. Look at the office, how many employees are there, who is helping the manager, meet other important people involved in the fund and specifically ask how long they have known the manager and what there basic role is in the fund.
c. Who custody’s your hedge funds assets? What prime broker does he use? Who does the monthly return accounting? Will he give you a contact at the prime broker and authorize the prime broker and or monthly accountant to disclose basic information about the fund; specifically, the funds assets (ask this after you have asked the assets under management). Walk away if the manager does his own accounting internally or if he custody’s funds internally for no good reason (a real estate fund for example doesn’t use a prime broker, but they will use a bank to hold the funds – call the bank and investigate his reputation with that bank).
d. Ask the manager for personal references not from investors but from people he has previously worked at in other fund management capacities. Call these references and verify there roles match the roles described to you by the manager.
e. Ask your manager under what conditions he would expect to make money and under what conditions he would expect to lose it – do not accept that he can make money in all markets – no strategy does this – require a better answer.
f.Review the terms of the investment, what are the liquidity terms, is there a gate provision in the documents? What are the risks. Read the offering documents. If there is ANYTHING you are uncomfortable with, walk away.
3. If you do not understand the strategy in even a basic way, then get a third party to review it or simply walk away. read more...
Related to Conducting Due Diligence on Hedge Funds:
- FINRA Broker Check
- Fund of Fund Due Diligence
- Hedge Fund Due Diligence Questions
- Institutional Hedge Fund Risk Controls
- Investment Due Diligence
- Due Diligence for High Net Worth Clients
- Hedge Fund Manager Due Diligence
- Hedge Fund Fraud | SEC & Hedge Funds Fraud Case
- Hedge Fund Regulation Corner | Compliance & Law Notes
- SEC on Hedge Fund Regulation
- Hedge Fund Risk Analysis