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“Trust, but Verify”

Gain insights on performing comprehensive due diligence for hedge fund investments to avoid risks and maximize returns. Learn about various quantitative and qualitative analysis techniques, operational considerations, fraud prevention, and regulatory challenges.

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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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