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“Trust, but Verify”

“Trust, but Verify”. April 20 th , 2011 FIRMA Annual Conference Atlanta, GA. W. A. (Trey) Ruch, III Executive Managing Director Sterne Agee Group truch@sterneagee.com. Quote for the Day. “If stock market experts were so expert, they would be buying stock, not selling advice.”

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“Trust, but Verify”

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  1. “Trust, but Verify” April 20th , 2011 FIRMA Annual Conference Atlanta, GA W. A. (Trey) Ruch, III Executive Managing Director Sterne Agee Group truch@sterneagee.com

  2. Quote for the Day “If stock market experts were so expert, they would be buying stock, not selling advice.” Norman Augustine RetiredLockheed Martin CEO

  3. Y is Due Diligence Performed? Understanding , investigating, and reporting the full range of primary known risks of any given hedge fund strategy and structure which can lead to significant loss of investor’s capital Usually to Answer a Binary Query: Invest/Don’t Invest? Remain Invested/Divest? Avoidance of Dire Consequences Illiquid and Frozen Capital Losses Worse than Worst Case Scenario Fraud or Defalcation

  4. ISO Qualified Managers • Conviction-Willing to put investment decisions ahead of business decision • Consistency-does not change style to conform to current market sentiment • Pragmatism-understand market efficiency and focuses on competitive edge • Investment Culture-passionate and proper organizational and comp structures • Risk Controls-not blind takers/acknowledge mistakes/appropriate controls • Active Return-long-term positive information ratios

  5. High Level DD Focus • Profile • People • Philosophy • Process • Price • Performance

  6. DueDiligence Steps

  7. Traditional Qualitative Panel

  8. Traditional Quantitative Focus • Quantitative Screening: • Returns relative to benchmark • Returns relative to peers • Risk Measures • Alpha • Information Ratio • Up/Down Capture Ratios • Sharpe Ratios • If Performance is an Outlier, is it Sustainable and Repeatable? • Holdings Based and Returns Based Attribution Analysis: • What is the source of outperformance? • Style Rotation • Security Selection • Sector Allocation

  9. Alternatives-Magnified Risks • Leverage-reasonableness standard varies across strategies • Operations-Complexity of derivatives, leverage, and complicated trading techniques • Fraud-Lack of transparency and level of complexity • Liquidity-illiquid underlying positions and valuation risks

  10. Alternatives-New DD Considerations • Increased Regulation-Staffing, systems, affordability • 2008 Recovery-Will funds swing for the fences? • Financing Challenges-Availability of leverage/financing and stable terms? • 2008 Recovery Challenges-Swing for the fences mentality • Redemptions-liquidity demands are up and fees are down….asset/liability mismatch?

  11. Investment Strategy Due Diligence

  12. Manager Related Due Diligence

  13. Operational Due Diligence

  14. Post Investment Monitoring

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