AIMA KPMG Study Shows Investors Need to Be Proactive About Due Diligence

A new study was recently released by hedge fund industry lobby group AIMA in conjunction with KPMG. They surveyed 150 hedge fund managers from around the globe. The study primarily focuses on the changing nature of the hedge fund industry focused on around asset flows and a predicted continuing trend of institutional investors continuing to allocate to hedge funds going forward.

One interesting point in the study was that the data showed that nearly 90% of the hedge funds surveyed reported increased investor due diligence since 2008. As part of this increased demand for due diligence, the survey also highlights the increased need for investor transparency in hedge fund operations. Interestingly, the data shows that those hedge funds have not universally responded by hiring additional staff to support the demands of this increased transparency. Of note:

  • 68% of hedge fund managers reported that they had not increased staff headcount in order to increase transparency management to investors since 2008
  • 69% of hedge fund managers reported that they have not increased staff headcount in order to respond to investors’ demand for due diligence

These findings are even more puzzling when considering that an overwhelming 88% of hedge funds indicated that they feel that investors have become more demanding in terms of due diligence since 2008.

So why would hedge fund managers acknowledge a trend of increasingly demanding due diligence, but not staff up to appropriately deal with these meetings and provide transparency?

While there is not one right answer to this question, there are likely a number of candidates including:

  • Some resource strapped hedge funds may not feel it is the best use of resources to focus on this area and instead are focusing on retaining investment talent or keeping profits
  • Hedge funds may feel that they can handle investor operational due diligence requests sufficiently with internal resources
  • Hedge funds may feel that the onus is on investors to drive the due diligence process

It is this last point that merits some discussion. Hedge funds take a myriad of approaches towards dealing with investor operational due diligence requests. Indeed, even the individuals responsible for overseeing the due diligence process can vary widely among different hedge funds. At a larger hedge fund for example, they may have an investor relations employee dedicated solely to responding to operational due diligence requests. At smaller firm’s the Chief Operating Officer may be the person overseeing the due diligence process.

In regards to responding to actual investor requests once again a myriad of options are present. For example, some hedge fund may have prepared their own operational due diligence questionnaire focusing on outlining some of the key areas of their operations which they want to alert investors about. Other hedge funds may have prepared a single due diligence questionnaire which touches on many aspects of the firm including fund investment thesis. Still others may have no due diligence questionnaire prepared at all.

Regardless of the approach taken by a hedge fund in response to the operational due diligence process, the AIMA KPMG study data highlights that in general hedge funds are not adequately staffed to consistently and proactively provide investors with the levels of transparency they require. As such, it is up to investors to drive the operational due diligence process and ensure that operational risks are fully vetted. Otherwise, investors may be at the mercy of a hedge fund whose priorities might be in other areas highlighted by this study, such as institutional asset raising, and not in providing institutional transparency.

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