Hedge Fund Due Diligence

Contents
2
Part One – Due Diligence Process ----------------------------- 3
Part Two – Due Diligence Focus ----------------------------- 11
Part Three – Bare-bones Due Diligence ----------------------------- 36
Terms & Definitions ----------------------------- 38
Appendix ----------------------------- 70

Part One – Due Diligence Process
3
3. Initial Contact
for Proposals
Initial Due Diligence Ongoing Due Diligence
1. Screening
5. Post On-site
Due Diligence
2. Desktop Due
Diligence
4. On-site Due
Diligence
Fund Monitoring
Final Decision
Part 2 – Due Diligence
Focus
Part 3 – Bare-bones
Operational DD

Initial DD – Screening
4
Process
Objectives
• One should determine what the new investment is trying to achieve – portfolio diversification, increasing exposure to a specific asset class
and/or strategy, achieving a targeted return, risk management, etc..
Criteria
• Based on the objectives, one should establish a set of screening criteria, such as liquidity, size, age, market focus, geography, tax treatment,
offering vehicles (pooled vs. Fund of One vs. SMA), etc..
Databases
• Internal – An Internal Database can reduce time and costs spent on research and improve screening efficacy.
• External – Third-party databases, such as Morningstar, Preqin and HFR, can provide a comprehensive and inclusive universe for screening.

Initial DD – Desktop Due Diligence
5
Performance
Analysis
Operation
Analysis
Business
Analysis
Offerings
Recent News
Desktop Due Diligence is designed to learn about the
basics of a fund before devoting more resources to an in-
depth research and analysis.
• Performance Analysis – ascertain a fund’s long-term
profitability and risks
• Operation Analysis – ascertain a fund’s operational
infrastructure and operating procedures
• Business Analysis – ascertain a fund’s business model
and potential for growth (i.e. SWOT analysis)
• Offerings – study a fund’s terms & conditions and
ascertain possible liquidity mismatches
• Recent News – study a fund’s culture and its
management team’s reputation
Process

Initial DD – Initial Contact for Proposals
6
On-site Due Diligence can be costly and burdensome. Before committing to it, Initial Contact for Proposals is an efficient and
cost-effective way to learn about a fund beyond Desktop Due Diligence.
Process
Initial Contact
A phone/conference call should be placed with a fund’s CIO/CEO and, possibly, COO and CFO.
The call should mainly focus on the fund’s strategy, management team and operations.
Request for
Information
If a fund is selected for On-site Due Diligence, a formal request for documents should be sent to the fund
manager.
Service Provider
Reviews
All service providers a fund currently employs should be reviewed before the on-site visit. Key focus should
be on operations, finance, legal and reputations.
Psychometric Test The objective of the test is to evaluate a fund manager’s personality, aptitude and mental agility.

Initial DD – On-site Due Diligence
7
Meetings
After the initial contact, this is where “put a face to the voice” takes place. We can learn the personality and character
of each member of the management team. This is also where to determine if we can get along with the management
team and have a productive relationship down the road.
On-site Due Diligence must be conducted at a fund’s office. If the fund has multiple locations, the targeted office should be the
one that focuses on and carries out the most important tasks (i.e. investment activities, valuation and reconciliation).
Functions
Observing different teams (i.e. front-office vs. middle-office vs. back-office) working in real-time and going through
their works can help better understand the fund’s operating process and procedures and detect any discrepancies
between what displayed and what stated in the offering documents.
Interviews
To gain insights into a fund’s operations, staff’s credentials and team dynamics, interviews should be conducted
across different teams, functions and seniority levels.
Office Setup
Observing its office’s location, size, and layout can help evaluate the fund’s operating efficiency and ascertain the
management’s plan for future expansion.
Process

Initial DD – Post On-site Due Diligence
8
Documents
Study documents that have
yet been reviewed
previously, especially the
ones that are requested
during On-site Due
Diligence
Psychometric Test Result
Study the test result to gain
a holistic understanding of
the manager’s personality,
aptitude and mental agility in
relation to the fund’s culture,
strategy and operations
Score Card
While it cannot be the sole
decision-maker, scores on
the score card can facilitate
the decision-making process
Reference Check
Ask & check the
management’s reference
Post On-site Due Diligence is designed to conduct one last review of the fund(s) before making the final decision. An
Assessment Report for each fund is produced at the end of this stage.
Process

Ongoing DD – Fund Monitoring
9
Monthly
● News and reports
● Updates on portfolio
● Updates on performance / account
information
Semiannually
information
● Follow-up calls with fund managers
● Peer group analysis
Daily / Weekly
● News and reports
information
Annually
information
● Strategy & operations compliance
● Possible on-site visit
Quarterly
information
● Market risk factors analysis
● Strategy compliance
● Regulatory filings
Process

Final Decision
10
Prospective Investments
Action List
Funds on this list are very attractive and ideal. Capital, if available,
should be allocated to them immediately.
Watch List
Due to one or more flaws in operations, funds on this list should be
actively monitored and capital should be allocated only when the
flaws are fixed.
No-fly List
Funds on this list should be avoided at all costs and will hardly be
reviewed again in the near future. There are several key
determining factors on why funds end up on this list.
Existing Investments
Retain
If a fund’s performance meets the expectation and its operations
are sound, it stays in the portfolio.
Wait or Replace
If a fund’s strategy is falling out of favor and experiencing
suboptimal performance as a result, it can be given more time to
show improvements or be replaced.
Exit
A fund’s performance or operations are no longer satisfactory.
There are several causes of irregular review / exiting from a fund.
Process

Part Two – Due Diligence Focus
11
Portfolios
Investment Due
Diligence (IDD)
Methodology Performance
Operating
Activities
Operational Due
Diligence (ODD)
Managers
& Staff
Offerings
Operational DD
Process

IDD – Methodology
Investment Strategy
Money Management
Risk Management
12
Focus

Investment Strategy
13
IDD – Methodology
How does a fund invest money in the market and generate profits?
Investment
Approach
- Quantitative: Use mathematical and/or statistical models and/or artificial intelligence (AI) to discover investment opportunities;
- Fundamental: Use publicly available financial data to evaluate the value of securities;
- Quantamental: A hybrid between quantitative and fundamental – uses both financial data and models/AI to evaluate the value of securities.
Investment
Style
- Directional: Investment is based on trends and momentum of the market;
- Non-directional: Investment is made regardless of the direction of the market (i.e. spread-trading).
Horizon
Average holding period for an investment. It is defined as short-term (days or weeks), mid-term (months) and long-term (years). Investment approach
and style often dictate investment horizon.
Investment
Process
From screening to research to final-decision making, a robust and replicable investment process indicates a fund’s consistent and predictable
behavior which leads to a high possibility of future success.
Instruments
A fund’s methodology dictates its use of instruments (e.g. equities, bonds, derivatives, etc.). The goal is to ascertain whether the instruments
employed are consistent with the fund’s methodology and risk profiles.
Concentration
- Equity: Geography (US, Asia ex-Japan, Japan, Europe, EM & Global); Market Cap. (Small, Mid, Large & Mega); Sectors / Industries;
- Convertible: Credit qualities; Sectors / Industries; Volatilities; Distress levels;
- Fixed Income: Credit qualities; Liquidity profile (high yield vs. high grade); Durations; Maturities.
Capacity
Constraints
An investment style, approach or process may no longer be viable when the AUM reaches a certain threshold (aka. the choke point). The complexity
of execution will also increase along with the growth of AUM.

Risk Management
14
IDD – Methodology
How does a fund protect its investment?
How a fund exits from a losing position:
• When and how to exit from a position to avoid either
further losses or premature exit?
• What’s the mechanism for exit? via a hard or soft stop? or
else?
Loss Protection
Study how a fund exits from a profitable position:
• When and how to exit from a position to maximize profit?
What about avoiding letting profits diminish and turning
into losses?
• What’s the mechanism for exit?
Profit-taking
Study how a fund manages its liquidity level given its strategy:
• What to do when encountering liquidity squeeze?
• What is the procedure for liquidating positions during
special situations, such as fire sale?
Liquidity Management
Study how a fund manages its portfolio under extremely volatile
market environment:
• How to manage its positions under both short-term and
perceived long-term volatilities?
Volatility Management

Money Management
15
IDD – Methodology
How does a fund manage and allocate its investable capital?
Study how a fund manages rewards vs.
risks:
• Is there a predetermined ratio that
represents how much AUM a fund is
willing to risk for a certain amount of
profit? Does the ratio vary from
position to position?
Reward-to-risk
Study how a fund allocates capital to a
position:
• How to determine the size of a new
position given its rising or shrinking
AUM?
• What is the min. and max. % of
AUM a fund allocates to a position?
Position Sizing
Study how a fund manages its cash:
• How much cash does a fund
reserve to meet its obligations?
• How does a fund manage its cash
income? reinvestment? distributing
to investors directly? or else?
Cash Management

IDD – Portfolios
Past Holdings
Portfolio Risk Factors
Portfolio Construction
16
Focus

Past Holdings
17
IDD – Portfolios
The goals are to ascertain 1) how much value a fund manager adds to the overall portfolio and performance; and 2) if the
manager has been consistent with the fund’s stated strategy, risk and money management.
It focuses on whether a manager’s
portfolio is significantly different from a
given benchmark to provide an
opportunity to adequately outperform an
index fund so as to justify compensating
for the differences in fees.
Active Share Analysis
1) Calculate the performance of a
manager’s portfolio for a specific
time frame
2) Calculate the performance of the
same portfolio as if there were no
changes in positions (no buying or
selling) throughout the entire time
frame
3) Compare the two performance
4) Repeat the process for several
different time frames to determine if
the manager adds value to the
portfolio
Gap Return Analysis
Study past holdings’ entries, exits,
capital distributions and overall
concentrations to ascertain if the
strategy has been consistent without
signs of style drift or purity issues.
Portfolio Consistency Analysis
wFund = The weight of the security in the fund
wIndex = The weight of the security in the index
Source: “The Science and Art of Manager Selection” by Robert Brown & Tom Lee, Mar. 2012
https://graphics8.nytimes.com/packages/audio/business/BarclaysFINAL.pdf

Portfolio Construction - 1
18
Weights / Focus Risk Exposure Ways to Leverage
Equity
1) Sectors and industries;
2) Geography;
3) Market capitalization (small vs. mid vs. large
vs. mega caps);
4) Instruments (e.g. stocks vs. derivatives);
1) Liquidity - inability to necessarily acquire
meaningful stake without moving the market or
inability to short a stock due to size or supply;
2) Capacity - constraints arise as a result of the
stock-selection universe and fund size;
3) Corporate events;
1) To investigate a fund’s level of leverage
- Gross Exposure = (L + S) / AUM &
Net Exposure = (L - S) / AUM;
2) Margin borrowing;
3) Derivatives;
Event
Driven
2) Geography;
3) Capital structure;
4) M&As;
5) Spin-offs;
6) Asset sales;
7) Divestiture;
1) Macro - general economic forces, e.g. market
vol., interest rates, exchange rates and
commodity prices;
2) Micro - specific transaction related, e.g.
earnings, financing, credit spreads, transaction
spreads, regulations, taxes;
2) Derivatives;
Fixed
Income &
Credits
1) Credit qualities (high yield vs. high grade);
2) Durations;
3) Maturities;
4) Geography;
1) Value-at-Risk (VaR);
2) Credits & Ratings;
3) Maturities;
4) Durations;
5) Currencies;
6) Geopolitical events;
1) Repos;
2) Derivatives;

19
Weights / Focus Risk Exposure Ways to Leverage
Convertibles
2) Geography;
3) Credit qualities (high yield vs. high grade);
4) Equities;
5) Bonds;
6) Volatilities;
7) Busted convertibles;
1) Premium Exposure & Cycle (premium spread
contractions and expansions);
2) Interest rates;
3) Equity markets;
4) Credit qualities;
5) Takeovers;
6) New issues;
7) Volatilities – delta & gamma;
2) Derivatives;
Global Macro
1) Geography;
2) Asset classes – equity indexes, rates,
currencies;
1) Political & geopolitical events;
2) Monetary policy changes (ECB & FEDs);
1) Derivatives;
Commodities
& Managed
Futures
1) Economic sectors (metals, agricultural
produces, energy);
1) Political & geopolitical events;
2) Policy changes;
3) Currencies;
4) Calendar spreads;
1) Derivatives;
Distressed
2) Equities;
3) Bonds;
4) Leveraged loans;
1) Chapter 11 Bankruptcy;
2) Credit ratings;
3) Liquidities;
Portfolio Construction - 1 IDD – Portfolios

Portfolio Risk Factors
20
IDD – Portfolios
Risks are associated with instruments, asset classes and overall
market conditions. A manager can minimize these risks through
diversification but cannot eliminate them.
1. Interest Rate Risk;
2. FX Risk
3. Credit Risk;
4. Basis Risk;
5. Market Volatility Risk;
6. Political / Geopolitical Risk;
7. Black Swan / Fat-tail Events;
Market Risk Factors (aka. Systematic Risks)
Risks are associated with a particular strategy or behavior of a
fund manager. A manager cannot minimize these risks through
diversification due to their “inherent” nature.
1. Directional Risk: long or short biased, market neutral, etc.;
2. Technical Risk: volatility, delta, correlation, etc.;
3. Spread Risk: industry tilts, sector tilts, style tilts, credit
spreads, etc.;
4. Concentration Risk: sectors, industries, asset classes, etc.;
5. Style Drift / Purity: short-term vs. long-term (or permanent);
6. Liquidity Risk*: Large cap. stocks vs. OTC derivatives;
Strategy Risk Factors (aka. Non-systematic Risks)
* Ability to exit from an individual position – It varies based on products. For cash equities, it is (1) # of shares owned over 20% of average daily trading volume for the past
3 months, ideally less than 7 days; or (2) Position Size over average daily trading volume for the past 3 months times 7, ideally less than 20% (Size / (Avg vol * 7) < 20%)
Source: “Essentials of Financial Risk Management” by Karen A. Horcher

IDD – Performance
Rate of Return
Analysis
Ratio Analysis
Attribution Analysis
21
Focus

Rate of Return Analysis
22
IDD – Performance
1. Rate of return (“RoR”) should be compared
against its peer group (funds with a similar
strategy, AUM size or market focus) and
relevant indexes (e.g., hedge fund index,
strategy index, etc.), and;
2. when performing a comparison, RoR should
be on a rolling basis and within the same time
frame, and;
3. RoR should be analyzed on a cumulative
basis, an annualized basis and a cash-flow
adjusted return basis.
Cash-flow Adjusted Return (Modified Dietz Return)
Source: “Investment Manager Analysis, A Comprehensive Guide to Portfolio Selection, Monitoring, and Optimization” by Frank J. Travers

Attribution Analysis
23
• Static Portfolio Analysis:
It is done on a specific time frame that does not take
transactions into account. Fundamental and value-driven
strategies should be analyzed on a quarterly or monthly basis;
trading-driven strategies should be analyzed on a weekly or
daily basis.
• Complete Portfolio Analysis:
Include all transactions within a specific time frame which
leads to more accurate results than static portfolio analysis
• Cycle Analysis:
Analyze performance in different markets (bulls & bears) and
economic cycles
• Absolute Attribution Analysis:
Analyze the effects of the characteristics of individual assets
& securities held within the portfolio. It can be performed on a
single time frame or bootstrapped to create a historical
analysis.
IDD – Performance
Individual Position Attribution
Sector Level Attribution Analysis
Source: “Investment Manager Analysis, A Comprehensive Guide to Portfolio Selection, Monitoring, and Optimization” by Frank J. Travers

Ratio Analysis
24
IDD – Performance
Sharpe Ratio
A manager’s excess returns
above a benchmark,
normalized by the standard
deviation of relative returns
Sortino Ratio
above a benchmark,
normalized by the standard
deviation of downside relative
returns
Treynor Ratio
It is a performance metric for
determining how much
excess returns were
generated for each unit of
beta taken on by a portfolio
Win-Loss Ratio
A manager’s average positive
relative returns divided by the
manager’s average negative
relative returns
Hit Ratio
(aka. “batting average”)
The percentage of periods
where a manager’s relative
returns were positive
Information Ratio
It measures portfolio returns
beyond the returns of a
benchmark, usually an index,
compared to the volatility of
those returns
Up & Down-market
Capture Ratio
during up (down) markets
divided by the benchmark’s
returns during up (down)
markets
Standard Deviation
It measures a fund’s
historical volatility
Downside Deviation
It measures a fund’s
historical volatility during the
down months / years
Maximum Drawdown
The % decrease in
investment value from its
peak to its trough. It is the
largest drawdown that has
ever occurred within a
specific time frame
Calmar Ratio
It is a comparison between
the average annual
compounded rate of return
and the maximum drawdown
Correlation Coefficient
The correlation of a
manager’s excess returns
with the returns of his/her
peer groups or indexes
Value at Risk (VaR)
It measures the amount of
potential loss, the probability
of that happening, and the
time frame for that to happen
Kurtosis
It measures the possibility a
fund will go through extreme
returns, both positive and
negative
Source: “Case Study #1: Selecting and Monitoring External Fund Managers” by IFSWF Subcommittee #2
https://www.ifswf.org/sites/default/files/Publications/oslocs1.pdf

ODD – Managers & Staff
25
Focus
Passion
Interest in investing in financial markets
Dedication to serving clients and managing the fund
Commitment to the fund’s long-term success
Perspective
Business plan
Reputation, lifestyle & experience
Behavior under stress
Purpose
Motivations for forming the fund
Alignment of interests
Progress
Operation improvements
AUM growth
Improvements on investor base
Managers Staff
Team
Structure
Setup
Size, composition & turnover rate
Members’ backgrounds and expertise
Training
Ongoing education and development
Inhouse workshops
Certifications (e.g. CFA, CRM, CAIA, etc.)
Relationship
Work history with managers and other team members
Personal ties with managers and other team
members

Managers & Staff
26
IDD – Manager(s) &
Team
Business plan
A manager must have a clear and concise business plan to showcase his/her goals for the fund, the strategy for achieving
those goals, and the time frame for the said goals to be achieved. A business plan can also entail the drive behind the
fund’s operations – improving performance? gathering assets? or preserving assets?
Behavior under
stress
Typical behavioral traits when under stress: 1) shifts in risk appetite; 2) shorter time-horizon on investments (less patient);
3) low level of engagement with coworkers; 4) increases in loss aversion; 5) confirmation bias.
Motivations for
forming the fund
Ascertain why the manager launched the fund:
1) Natural career progression - career has reached to the starting-my-own-fund level, or;
2) Unhappy employees – the manager no longer wanted to work for others as an employee, or;
3) Lack of employment opportunities – unable to find a suitable employment, or;
4) Opportunists – an opportunity for launching the fund presented itself.
Alignment of
interests
The fund manager’s interests must be in line with his/her investors’:
1) Co-investment – a significant amount of the manager’s own wealth should be invested in the fund (aka. skin in the
game). The offering terms and conditions should be the same as what are offered to investors.
2) Compensation structure – the manager’s pay, bonus structure and crystallization policy should be in accordance to the
fund’s performance. Rolling multi-year basis performance compensation scheme is highly preferred.
Improvements on
investor base
High QUALITY investors (a.k.a. institutional investors) indicate a high level of capital stickiness, which means less
occurrences of capital redemption. A large QUANTITY of investors indicates less impact on PnL led by individual
redemptions.

Team Setup
27
IDD – Manager(s) &
Team
Function Separation
&
Segregation of Duties
Conflicts of Interest Structural Reviews
A Great Chinese Wall should be built to
separate team members from different
functions and duties.
A team should employ arm’s length
practice among team members to
eliminate the possibility of being influenced
by others while performing tasks.
A team should be structured as such to
avoid overly relying on one individual for
its entire operations. Key knowledge and
information should be shared with one
another.
There should be a clear distinction among
front, middle and back-office teams. Each
team should not be mingling with other
teams’ tasks and responsibilities.
There must be a proper disclosure policy
in place for all team members.
A team should be structured as such to
ensure each member is suitable to carry
out specific tasks based on his/her
knowledge, experience and skill sets.
There must be guidelines on personal
account dealings and compliance.
There should be a sound reward system
for all teams and team members.
A team should be comprised of skilled, experienced members with clearly defined responsibilities.

ODD – Operating Activities
Investor Relations
Operational Support
Trade Execution
28
Focus

Investor Relations
29
ODD – Operating
Activities
Investor relations includes business development, marketing and client service. Emphasis on each activity can vary from fund
to fund. The goals are to 1) find out how a fund structures these activities and 2) determine if it has the necessary skills and
resources to be successful in each activity.
Business Development
Requirements: People Skills & Resources
Areas of focus: Relationship Management
& Fundraising
➢ Identifying new investor base, and;
➢ conducting introductory calls, and;
➢ coordinating and hosting meetings with
potential investors, and;
➢ networking.
Marketing
Requirements: Knowledge & Expertise
Areas of focus: Brand Management &
Public Relations
➢ Brand promotion, and;
➢ designing and preparing documents
such as pitch books, investor reports,
due diligence documentation, etc., and;
➢ coordinating and hosting industry &
investor conference.
Client Service
Requirements: Transparency & Knowledge
Areas of focus: Relationship Management
& Communication
Source : “AIMA’s New Invesor Relations Guide” by AIMA, July | August 2016 issue
https://thehedgefundjournal.com/aima-s-new-investor-relations-guide/
➢ Client onboarding, and;
➢ distributing investor reports, and;
➢ investor request management, and;
➢ coordinating and hosting update calls /
meetings.

Trade Execution
30
ODD – Operating
Activities
Due diligence should focus on a fund’s 1) technology and trading infrastructure, 2) execution process and procedures and 3)
compliance.
Order Management System
(“OMS”)
Ascertain if a proper OMS setup is in place
Execution Ascertain the % of trades executed internally vs. via third-parties (i.e. execution brokers)
Lending Agreements
Review lending agreements with all counterparties to ascertain a fund’s financing and liquidity-
management capabilities
Level 3 Assets Review a fund’s policy and procedures for executing level 3 assets
Records
Review a fund’s trade logs to ascertain its policy and procedures for recording trading activities
Review a fund’s record on execution mistakes and mandate breaches (i.e. unauthorized trading)
Operational DD

Operational Support
31
ODD – Operating
Activities
Valuation & Pricing Audit Cyber Security Practice
Corporate Actions and Proxy
Voting
Reconciliation
Accounting & Financial
Statements
Business Continuity
System for Transfer Agency
(i.e. subscriptions,
redemptions, provision of
investor statements and
preparation of financial
statements)
Trade Allocation, Confirmation
& Error Management
Fund’s Expenses Legal Structures
Risk Management Settlement
Commissions & Fees
Management
Risk Monitor & Control
Cash Management & Wiring
Transfer
Anti-money Laundering
(“AML”)
Compliance Technology & Infrastructure
Clearance & Collateral
Management

ODD – Offerings
Terms
Liquidity
Vehicles
32
Focus

Terms
33
ODD – Offerings
Manager Compensation Contribution
Management Fees:
It is to cover a fund’s expenses and charged either
monthly, quarterly or annually
High-water Mark:
Previous losses must be recouped before a manager
is entitled to performance fees
Minimum Initial Contribution:
The minimum amount of capital a new investor is
required to invest
Performance Fees:
It’s to align a fund’s interest with investors’ and
charged annually based on performance
Hurdle Rate:
A manager is entitled to performance fees only after
the performance surpasses a certain threshold.
Minimum Subsequent Contribution:
The minimum amount of capital an existing investor is
required to invest
Claw-back:
A manager is required to return a % of past performance fees during an underperforming period
Contribution Frequency:
How often an investor can allocate additional capital
to the fund
Withdraw / Redemption
Lock-up:
A period of time when an investor’s capital is not allowed to be redeemed
Redemption Period:
A time frame when an investor is allowed to request for redeeming capital
Gates:
The amount of capital an investor can withdraw at once. 1) Fund Gate: % of a
fund’s total AUM can be redeemed in a given period. 2) Investor Gate: % of an
investor’s capital can be redeemed in a given period
Redemption Frequency:
How often an investor can request for redeeming capital
Side Letter Side Pockets
It allows a fund to negotiate special offering terms with individual investors, which
often carries better terms like Most Favored Nation (“MFN”).
A side pocket allows a fund to separate illiquid assets from the main portfolio that
holds liquid assets

Vehicles
34
ODD – Offerings
Co-mingled All investors’ capital is pooled into one account
Pros: low costs and easy to maintain, economy of scale on operations
Cons: 1) depending on LPA, PPM, and other offering documents, transparency can be limited; 2) individual redemptions can cause PnL damage
to all investors; 3) PnL dilution occurs when new capital enters into the fund
Fund of One
Each investor has his/her own account but assets in the account are legally owned by the fund manager, not the investor.
The fund manager bears all liabilities
Pros: 1) offers greater transparency than co-mingled; 2) PnL can be less impacted by redemptions from other investors
Cons: due to additional burden on operations and maintenance, the fees service providers charge could be higher than co-mingled
SMA
Each investor has his/her own account and the assets in the account are legally owned by the investor instead of the
manager
Pros: 1) provides the greatest transparency on position holdings, trading, etc.; 2) very flexible and can be tailored by the manager to the investor's
preference
Cons: 1) Investors bear all liabilities (i.e. derivative positions) and the name of the investor will be disclosed to the regulatory bodies; 2) due to
additional burden on operations and maintenance, the fees service providers charge could be higher than co-mingled

Liquidity
35
ODD – Offerings
The level of market liquidity is dictated by 1) macroeconomic environment, 2)
characters of an instrument, 3) the structure of the market of which the asset is
traded, and 4) settlement cycles.
It is defined as the availability of credit to finance the purchase of assets
(leverage), and a fund’s ability to meet its debt obligations in a timely fashion.
It defines how easy for an investor to redeem capital from the fund. Different
types of redemption restrictions (i.e. gates and lock-ups) lead to different levels
of investor liquidity.
Different strategies inherit different levels of liquidity.
Source : “Paper 4 : Efficient Flows, Understanding liquidity in alternative investment funds” by Jack Inglis & Tom Kehoe
https://www.aima.org/static/uploaded/7656e745-4db1-4bf9-a09924216e53225c.pdf

Part Three – Bare-bones Operational Due Diligence
36
As hedge funds come in all shapes and sizes, ODD can vary greatly from fund to fund. Bare-bones ODD is designed to focus
on the basic yet important components of a fund’s operations regardless the fund’s age, size, location, etc.
Middle Office
Bare-bones ODD
Front Office Back Office Firm-wide Focus
Trade Execution
Post-trading Activity
Management
Risk Management
Valuation
Fund Admin’s abilities and
capacities
Compliance Setup
Operating Procedures &
Standards
Disclosure Policy (level of
transparency)
Focus
Process
Prime Broker Management

Firm-wide Focus
37
Operational DD
Compliance Setup
• At a minimum, a fund should establish a written code of ethics, which can be included in either “LPA” or “PPM”, that
generally applies to all employees addressing issues such as integrity and professionalism, the responsibilities of the
manager as fiduciary, protection of confidential information about the fund and its investors, and personal trading by
fund personnel.
Operating
Procedures &
Standards
• At a minimum, a fund should have policy in place to manage its cash, margin and collateral requirements, for the
selection of counterparties and key service providers to the fund, and for core infrastructure and operational
requirements at the fund (including clearing and settling transactions, wiring funds, reconciling positions and cash
accounts across counterparties, and appropriate automation of trading process).
• The fund’s systems, infrastructure, and automation should commensurate with the scale of its business and trading
operations. In addition, they should be flexible to meet short-term growth and adequate for long-term expansion.
Disclosure Policy
(level of
transparency)
• At a minimum, a fund should clearly convey its investment philosophy, strategies, products and terms, significant
risks of investing in the fund, the elements of the fund’s valuation framework, and potential conflicts of interest to its
potential investors.
• The fund should provide regular and consistent updates on the fund’s quantitative information (aka. performance)
and qualitative information (aka. market views, fund's operating updates, etc.)
• The fund should properly disclose all of its counterparties and their risks, accounting practices & policy &
compliance, essential operational procedures and compliance.
Source : “Best Practices for Hedge Fund Managers and Investors” James Morphy, Sullivan & Cromwell LLP, Jan.31.2009
https://corpgov.law.harvard.edu/2009/01/31/best-practices-for-hedge-fund-managers-and-investors/

Terms & Definitions
38
Contents

Internal Database
An internal database should contain information on
funds that have been researched and studied for the
past 18 – 24 months.
• Only factual information should be stored in this
database; subjective, personal opinions need to be
excluded and avoided.
• To ensure the accuracy of information in this
database, it is of utmost importance to perform semi-
annual, if not quarterly, updates. Proper database
maintenance can further enhance research efficacy.
• This database should be prioritized over third-party
databases when searching for new funds. However,
funds within should not be automatically viewed as
more favorable than funds from other databases.
Contents
Marketing
Materials
Form ADVs
(for US)
Investor
Reports
Meeting
Memos
Initial DD – Screening

Investor Reports
Investor reports should, at minimum, cover both portfolio activities and business operations. In addition, the depth of the report
can be an indicator of a fund’s commitment to transparency.
Internal Database
Portfolio Activities Should Include: Business Operations Should Include:
1. Performance and NAV for the reporting period, and;
2. overall market commentary and winners/losers of the reporting
period, and;
3. net and gross exposure (to show the level of borrowing/financing
the fund is employing), and;
4. information on level 3 assets and side pocket(s), and;
5. major holdings, and;
6. currency hedging and exposure, and;
7. portfolio holding analysis by liquidity, industry/sector, and market.
1. Information on the investment team, and;
2. information on the operations team, and;
3. information on all service providers, and;
4. information on pending litigations and regulatory activities in
relation to the manager or the fund, and;
5. information on any implemented or planned changes to the
manager or the fund, and;
6. information on valuation – proportion of the NAV represented by
assets that have been independently valued.

Documents
Initial DD – Initial Contact
for Proposals
To be fully prepared for On-site Due Diligence, all relevant documents should be reviewed beforehand. If additional documents
are needed for clarification, they should be requested during On-site Due Diligence.
Due Diligence
Questionnaire
Audited Financial
Statements (Min. 3 yrs.)
Fund Organizational
Documents
Marketing Materials
(i.e. pitchbook)
Offering Documents*
Team Info. & Bios
Valuation Policy
Compliance Manual (incl.
p.a. trading, AML &
electronic communication)
Operational Policy &
Procedures
Monthly Performance &
NAV History
Counterparty Exposure
Reports (incl. a list of all
counterparties)
Recent Investor Reports &
Communications
Fund Admin Agreements
Prime Broker Agreements
(incl. trading agreements)
Custody Agreements
Audit Engagement Letters
Trade Flow Diagram
Organizational Charts
System Flow Charts
Recent Daily Reconciliation
Reports
Minutes from Recent
Meetings
SSAE 18 (SOC I & II),
ISO9000, AAF1/06 reports
Staff Retention Rate
Recent Risk Summary
Reports
Form ADV I&II and
Schedule F (for US)
* Offering Documents include Offering/ Placement Memorandum, Prospectus, Tear sheet, Limited Partnership Agreement (“LPA”, onshore), Investment Management Agreements
(“IMA”, offshore), Memorandum and Articles of Association (offshore), Certificates of Incorporation, Marketing and Distribution Agreements and Subscription Documents. All documents
are preferably obtained directly from the fund admin.

Service Provider Reviews
Fund Administrator
Reviews
Prime Broker Reviews Auditor Reviews Custodian Reviews
for Proposals
Service Provider’s
Contract Reviews

Fund Administrator Reviews
Things to
consider:
Past & current status of relationship with the fund (why did the fund choose this fund admin?)
Past & current status of relationship with banks it operates and the types of accounts it holds with the bank(s)
The types of services offered to the fund (full vs. lite) and the remuneration arrangements
Independent channel of communication with other service providers (e.g. PBs, auditors, custodians, etc.)
Stable connectivity with the fund, the fund’s other service providers and vendors to ensure speedy and accurate
file/data exchanges
Systems, manuals, checklists, review and authorization procedures for transfer agency
SSAE 18 (SOC I & II) reports, regulatory and compliance records
Valuation – 1) calculation method for NAV and performance fees – equalization, series accounting, or “rough justice”; 2)
independent valuation vs. co-work (where the fund can override the valuation) vs. independent valuation verification
(i.e. lite service); 3) pricing data used for valuation; 4) records of conflicts with the fund and NAV restatements
AML checks and compliance
Business continuity arrangements and disaster recovery plan which includes where the fund’s books and records are
maintained and how they are protected against damage and loss
Contract Reviews
Operational DD
for Proposals

Prime Broker Reviews
Things to
consider:
Past & current status of relationship with the fund (why did the fund choose this PB?)
Multiple PBs – 1) functions/services; 2) fund’s exposure; 3) asset and account segregation; 4) geographical coverage;
5) record-keeping policy & procedures; 6) communication policy
The types of services offered to the fund (full vs. execution only) and the remuneration arrangements
Independent channel of communication with other service providers (e.g. fund admins, auditors, custodians, etc.)
Stable connectivity with the fund, the fund’s other service providers and vendors to ensure speedy and accurate
file/data exchanges
Reports to the fund and the fund manager(s) should include trading, valuations, investment restriction breaches,
covenant reporting and information by strategy and portfolio
SSAE 18 (SOC I & II) reports, regulatory and compliance records
Lending agreements
Joint liability and cross-class liability
Fund Administrator
Reviews
Auditor Reviews Custodian Reviews
Operational DD
Contract Reviews
for Proposals

Auditor Reviews
Things to
consider:
Past & current status of relationship with the fund (history of change auditors?)
Previous audit reports on the fund
Independent channel of communication with other service providers (e.g. fund admins, PBs, custodians, etc.)
Auditing coverage – what’s included? Does the auditor review dealings and valuations?
Auditing & accounting standard of compliance
Auditing procedures
Latest signed financial statements and NAV valuation reports
Fund Administrator
Reviews
Prime Broker Reviews Custodian Reviews
Contract Reviews
for Proposals

Custodian Reviews
Things to
consider:
Past & current status of relationship with the fund
Cash management and transfer process, procedures & policy
Insurance or bonding to protect against possible losses
Independent channel of communication with other service providers (e.g. fund admins, PBs, auditors, etc.)
Asset segregation between the fund’s and its own
Fund Administrator
Reviews
Prime Broker Reviews Auditor Reviews
Contract Reviews
for Proposals

Service Provider’s Contract Reviews
Ensure quality services from providers Protection
Determine what remuneration is payable under the contracts
Review terms regarding intellectual property rights and
confidentiality clauses
Who is responsible for what Identify all parties that could be involved under the contract
Understand the liability and indemnity clauses that operate under
the contracts
Review the extent to which the contracting parties can assign and
delegate the provision of services, rights, liabilities and indemnities
to other groups, companies or third parties
Ascertain what the fund has paid for Jurisdiction & Validity
Establish exactly what services are to be provided under the
contract
Ascertain the governing law of the contract and which court is
deemed to have jurisdiction
How can the relationship end Execution
Review the basis on which the agreement can be terminated
Ensure the contract has been properly executed by all parties
involved
Understand the financial ramifications Amendments
Review default clauses and covenants to understand what would be
considered to be an event of default or breach of covenant
Review all amendments
Fund Administrator
Reviews
for Proposals

Initial DD – On-site Due
Diligence

Management Team
Investment Team Investor Relations Team IT Team & Legal Team
Diligence
Goals:
Find out who oversees daily portfolio management
Find out who oversees daily risk management
Find out who backs up the PM (i.e. the junior PM(s))
Find out the types of investors invested in the fund (i.e. institutional investors vs. HNWI vs. management’s own
capital) and top 3 biggest investors by % of NAV
Find out if there are other than professional relationships exist among managerial members of the team (e.g.
independent director of the fund has a personal tie with the PM)
Find out the kind of infrastructure the fund employs
Find out the frequency of portfolio related meetings
Find out any changes in investment personnel and service providers (PBs, Fund Admins, Auditors, etc.)

Investment Team
Management Team IT Team & Legal Team
Diligence
Goals:
Find out team dynamics and relationships among members (“how well they work together?”)
Find out members’ backgrounds, expertise and responsibilities
Find out the decision-making process for buying & selling securities and ask for examples
Understand the strategy and portfolio construction (confirm with prior research for coherence, consistency and
accuracy)
Find out the PM’s best and worst trades since inception and understand why
Find out if the PM has had a record of failed investment fund(s)
Find out if there is a history of changing PMs or modifying investment style and/or strategy
Discuss personal experiences of working with other team members
Discuss the research process and walk through a real-life research example
Discuss the technology and infrastructure the team employs to conduct research and execution
Discuss strengths and weaknesses of the team
Investor Relations Team

Investor Relations Team
Management Team Investment Team IT Team & Legal Team
Diligence
Client Service Function
Goals:
Find out the team’s experience/familiarity with the
fund’s offering strategy
Find out the team’s possessed resources and
availability to serve if allocating capital to the fund
Find out the number of clients each team member
serves and the client-distribution ratio among
members
Ask for examples of client communications (e.g.
reports, commentaries, etc.)
Marketing Function
Goals:
Find out the team’s experience and track record of
raising assets
Find out the team’s familiarity with the fund’s offering
strategy
Find out the team’s area(s) of focus and possessed
resources
Find out the team’s compensation package/pay
structure

IT Team & Legal Team
Diligence
Management Team
Investment Team Investor Relations Team
Legal Team
Goals:
Find out the compliance procedures
Find out how violations are being tracked and
reported
Discover any past and pending litigations
IT Team
Goals:
Find out the systems and infrastructure employed to
support the firm’s operations and portfolio
management (in-house vs. outsource)
Find out the availability and security of remote access
to the firm’s network
Find out the policy and measures on cyber security
Find out the system backup procedures & disaster
recovery system and who oversees it
Find out the go-to person(s) for trouble-shooting
Find out the frequency and regularity of system
upgrades

Assessment Reports
An assessment report is an executive summary where the researcher highlights findings and offers recommendations. As
assessment reports are opinion driven, to avoid conformation bias, the researcher should discard them after each use.
Initial DD – Post On-site
Due Diligence
Firm Overview
Strategy
Assessment
Performance
Analysis
Portfolio’s Strength
& Weakness
Scores on the
Score Card

Causes of Rejecting a Fund - 1
Cause of Rejecting a
Fund - 2
Lack of experience on the short side
Lack of attention to optimizing hedging
techniques and reducing their cost
Lack of appreciation of the existence of a
denominator, that is, a finite capital base
This is a problem especially with former
mutual fund managers. Clues: shorts
based on valuations alone, oversized
positions or an admission from the
manager that he or she looks at the short
book as insurance, rather than as a profit
generator.
Look out for: small or mid-cap equity
managers who hedge their portfolios with
S&P or FTSE futures or ETFs. This is an
unintended long mid-cap/ short large-cap
bet, rather than a hedge.
This is a problem especially with
proprietary traders who are used to trading
a line of credit. Look out for: imaginative
track records and creative ways of defining
invested capital.
Lack of appreciation of the business
aspects of managing a hedge fund
Closet longs Lack of portfolio management skills
Look out for: lack of a strong CFO/COO,
who can free the manager up to focus on
investing.
For a long-only fund, if net long exposure is
close to or over 100%. One does not need
to pay a 20% incentive fee for leverage.
This problem is often encountered with
former sell-side analysts managing sector-
specific funds. Evidence: oversized buy-
and-hold positions in household names.
Source: “Manager Selection – process of elimination”, by Norman Chait, Feb. 2001
https://www.ipe.com/manager-selection-and8211-process-of-elimination/13926.article
Final Decision

Causes of Rejecting a Fund - 2
Cause of Rejecting a
Fund - 1
Final Decision
Lack of knowledge of what else is out
there, such as competitive products
Use of third-party money raisers and
sponsors, who have bad track records
Aggression in the capital raising process
For example, there is no reason to invest in
a private placement unsecured convertible
fund, when there are other managers who
provide a better risk-reward opportunity by
investing in secured debt with warrants.
One should note if too much of the capital
comes from the typical “hot money”
sources. Observe: whether managers have
not met all of their end investors. Also
observe if the manager attends a
disproportionate number of hedge fund
conferences.
Think twice when: the manager declares
that there will be a one-time closing. Funds
have a funny way of reopening from time to
time, so there is no rush to invest large
amounts from the outset.
Unclear motivations for forming the fund Aggression in creating new products Poor offering terms
Some new managers create investment
companies because they do not have more
attractive employment alternatives, or
because they want to slow down rather
than speed up. One hint: look out for
former institutional salesmen who are
suddenly in charge of risk management.
Attempts to create many products, rather
than one fund that incorporates the
manager’s best ideas. Usually someone
else, such as a sponsor or large client, is
driving product development.
Uncompetitive fee structures or liquidity
terms, such as lock-ups, that are less
favorable than those provided by the new
manager’s direct, more established
competitors.
Source: “Manager Selection – process of elimination”, by Norman Chait, Feb. 2001
https://www.ipe.com/manager-selection-and8211-process-of-elimination/13926.article

Causes of Irregular Review / Exiting From a Fund
Final Decision
Headlines
Involved in regulatory investigations
Involved in negative press and/or news
Organization
Key personnel’s departure
Key personnel changes in non-investment departments
Poor talent management – loss of star employees
Increases in staff turnover
Rapid / excessive introduction to non-complementary new products
Losing AUM / AUM stagnation / excessive AUM growth
Operations
NAV restatements and/or revisions
Out of compliance
Material changes in offering terms
Material changes in policy and procedures, e.g. valuation,
reconciliation, reporting, etc.
Deterioration in transparency (standard of disclosure) and/or
frequency of communication with investors
Changes in service providers, especially the auditor
Investment
Style drift and/or deterioration in strategy purity
Over exposure to a specific sector, industry, duration, etc.
Prolonged suboptimal performance*
Worsening portfolio risk factors
Questionable changes in investment decision-making authority
* “If a manager’s underperformance is due to unfavorable style for the period of market, it should be given up to 2 years for the manager to make a comeback.”
- Newport Group

Valuation & Pricing
Operational Support
Personnel
A dedicated, experienced personnel/team who are independent from the investment and trading teams should oversee the entire process
Identify all parties involved in the process (i.e. preparation of pricing marks, verifying & checking marks, and reviewing the correct use of the marks)
Determine if a fund’s PM is involved in any part of the process
Manuals
A written manual on methodology, procedures and source(s) for valuing each asset
class that are in compliance with FASB
The manual should include 1) rules, procedures and process for price overrides or
deviation; 2) documentation process for price overrides or deviation; 3) reviewing
process for price overrides or deviation; 4) rules, procedures and process for pricing
level 3 assets; 5) stale price identification
Governance
Determine if there is a mechanism in place to independently monitor, implement, and
periodically review designed valuation policy and procedures
Review the compliance of valuation records and determine the source of compliance
oversight
Determine if there is a mechanism in place to segregate duties between valuation
and investment teams
Operational DD

Reconciliation and Trade Allocation, Confirmation & Error
Management
Operational Support
Trade Allocation, Confirmation & Error Management
Personnel:
A dedicated, experienced personnel/team who are
independent from the investment and trading teams
should oversee the entire process
Manuals:
A written manual on policy and procedures for
allocating and confirming trades, identifying trading
errors and fixing trade breaks
Governance:
Have a detailed record of trade discrepancies, errors
and breaks
Have a well-structured communication channel with
counterparties to solve trade disputes
Reconciliation
Personnel:
Reconciliation should be conducted 3 ways – Fund
Admin, PBs and the fund’s OPS team (maintaining
independent communications)
Determine if a fund’s PM is involved in any part of the
process
Manuals:
A written manual on reconciliation process and
collateral management process
The manual should include a clear definition of
reconciliation frequency – how often should
reconciliation takes place for level 1, 2 and 3 assets
respectively

Risk Management
Operational Support
Market Risk:
It should include stress testing and scenario analyses (standardized, historical and unique), as well as
forward-looking risk measures
Liquidity risk – credit and lending agreements, with particular focus on risks derived from counterparties’
failures (i.e. 2008 Lehman Brothers) and risks of using short-term, cash-like instruments to substitute cash
Product risk - ascertain risks associated specifically with asset classes and financial instruments
Operational Risk:
It should include strong internal control and operational infrastructure to commensurate with the fund’s size
and complexity
Counterparty risk – review and monitor credit exposure to counterparties
Human risk – evaluate the risks caused by man-made errors
Risk management focuses on managing two types of risk – 1) market risk and 2) operational risk.
Operational DD

Risk Monitor & Control
Operational Support
Personnel:
A person/team who oversees this function should have extensive experience and knowledge in various risk
factors, risk identification and risk-management techniques
The person/team must be independent from the investment and trading teams and avoid being influenced by the
PMs
The person/team must commit to a strict monitoring and control process and uphold its standards
Infrastructure
&
Systems:
Infrastructure should be built on a firm-wide network where can be reviewed and studied by all relevant parties in
a timely fashion
If a firm runs multiple strategies, the system should be flexible enough to provide tailored reports to each
individual PM and strategy
A fund should conduct periodical stress tests to ensure the validity and reliability of its risk models.
Manuals:
A written manual should be established and include risk monitoring policy and procedures, criteria for risk
measurement and control, and protocols for risk management
Governance:
A fund should keep a detailed record of communications among PMs, traders and its risk management team
A fund should conduct periodical reviews on risk monitor & control setup and exam for potential loopholes

Compliance and Audit
Operational Support
Audit
Personnel:
A designated personnel (internally & externally) with
adequate resources should oversee the policy and
procedures while maintaining independence and total
control
Manuals:
The manual should detail the frequency of audit, the
coverage and procedures for internal & external audit,
and process for routine checks.
Governance:
There should be adequate planning, controlling and
recordkeeping of all work, includes findings, conclusions
and recommendations
Compliance
Personnel:
A designated personnel/team should be responsible for
monitoring and maintaining the compliance program,
disciplinary procedures and sanctions
The designated personnel/team should maintain
independent and total control over the compliance
program and define an appropriate frequency for
periodical reviews
All involved personnel should receive regular education
and training
Manuals:
The manual should include written code of ethics that
establishes principles governing the conduct of the fund
The manual should address various rules and
regulations on governing the operations, identifying
conflicts of interest in operations, and recordkeeping
practice
The manual should provide clear guidelines on topics
regarding personal account dealing, electronic
communication, gifting and soft-dollar policy

Accounting & Financial Statements
Operational Support
• Reviews should be conducted on audited financial statements for at least past 3 years. All financial statements should come directly from the
fund’s auditor
• The following sections deserve extra attention when review the statements: a) “Schedule of Investment”, b) historical positions, c) cash flows,
d) holdings on illiquid and hard-to-value assets (side pockets), e) fund expenses
• NAV Reconciliation – review financial statement NAV vs. year-end dealing NAV; the differences could be caused by different share classes,
prices marking differences (fair-value vs. bid-ask spread), or accruals of income and expenses
• Investments and Valuation Methods – review valuation methods on assets that surpass 5% of the NAV, illiquid assets and side pocket(s)
• Capital Structure and Policy Changes – review the consistency of capital structure, voting rights, cross-acceleration, cross default obligations
and rights to borrow by other funds (should be included in the footnotes)
• Service Providers – review all service providers stated in the statements
• Special Liabilities – review footnotes and disclosures for litigation incidents (i.e. legal fee expenses)
• Investors – review its cashflow and number of investors to ascertain the fund's AUM growth or decline
• Accounting reviews should also include reviews of a fund’s leverage – a) Debt-to-Equity Ratio – appropriate coverage when lenders calling for
capital; b) Cash/Dry Powder – appropriate level of reserve to meet its short-term obligations; c) Balance Sheet Strength – the ability to handle
sudden increases in collateral requirements (aka. haircut) for funding positions

Fund’s Expenses
Operational Support
Review
Study a fund’s Total Expense Ratio (“TER”) QoQ and YoY to identify the trend
Examine the expense structure to determine proper cost allocation (the management company vs. the fund). For
instance, travel expenses should be marked on the management company level instead of the fund level.
Budgeting
Review a management company’s budgeting and ascertain if there is sufficient funding to support its fund’s
ongoing operations and future expansion.
Expense Absorption
Methods
100% Pass-through: a fund passes all of its operating expenses on to investors, as an add-on to the
management fees
Mingled (aka. Fixed/Caped): a fund passes a part of its operating expenses (% of AUM) on to investors and
absorbs the rest internally with its revenue from management fees
Float: a fund asks investors to pay for its expenses instead of charging management fees
Internal Absorption: a fund absorbs its expenses with its revenue from management fees
Calculation Methods Exam the calculation methods for fees and NAV to ensure its consistency

Settlement and Cash Management & Wiring Transfer
Operational Support
Cash Management & Wiring Transfer
Personnel:
Fund Admin should have independent control over the
procedures
Designated personnel (i.e. CFO) should monitor,
manage and process cash-related activities and
reconcile with the Fund Admin
Setup:
A fund should establish a well-defined procedure that
involves all relevant parties (Fund Admin, Funds,
Investors)
A fund should retain a written manual on cash wiring &
transferring procedures and collateral related process
and policy.
Storage:
Cash should be store either in the money market or with
custodian(s).
Settlement
Personnel:
A designated personnel/team (internally & externally)
with adequate resources should oversee the policy and
procedures while maintaining independence and total
control (No conflicts of interest)
To ensure a proper check and balance is in place, two
senior staff are often involved in monitoring and signing
of transactions
Manuals:
The settlement instruction manual should address
Delivery vs. Payment (DvP) & Delivery vs. Free (DvF)
as well as how settlement breaks are recorded and
caught up.
Source : “Comparison of Delivery vs. Payment (DVP) and Delivery vs. Free (DVF or Free) ” by Fannie Mae
https://singlefamily.fanniemae.com/media/4636/display

Technology & Infrastructure and Cyber Security Practice
Operational Support
Cyber Security Practice
Training:
A fund should conduct periodical training to raise staff’s
awareness and develop proper prevention measures
Setup
&
Testing:
System setup should be flexible and provide access
points for various devices
Periodical testing should be conducted to exam
potential loopholes and bugs within the system
Record:
Review the fund’s breach record to determine if the fixes
have been adequate
Technology & Infrastructure
Personnel:
A designated personnel/team, either inhouse or
outsourced, with adequate resources should oversee
the setup and maintenance
The personnel/team should be readily available to solve
technical issues and answer related questions
Setup:
System setup should not only meet current needs but
also be appropriate for scaling in the future
The system should be periodically tested for its
efficiency, cost-effectiveness, robustness and reliability
Governance:
A record should be maintained on customization and
upgrades
A proper policy should be in place to cope with issues
regarding redundancy, partial duplication and legacy
system

Business Continuity
Operational Support
Disaster Recovery Plan
Personnel:
A designated personnel/team, either inhouse or
outsourced, should be involved in the process of
restoring business operation and updating the plan
Regular training should be provided to all staff
Manuals:
The fund should retain a written manual for clear
planning and instruction on each action to be taken in a
disastrous scenario
It should also cover topics regarding call tree orders,
technological backups, backup & copy of essential
documents and backup facilities
Test:
The fund should conduct periodical stress tests on this
plan and keep a record of all test results.
Key Man Clause & Succession Plan
Minimum
Coverage:
Authority and responsibility allocation upon the key man
becomes incapable of performing, and;
investment decision making matrix & risk management
process in an event of key person of the fund has
become incapacitated, and;
method and process of notifying such events to
investors, and;
unwinding procedures if it's required, and;
set up new ownership & management structure for the
future of the business.

Legal Structures
Operational Support
The way a fund sets up its legal structures has direct impact on matters regarding taxation and liabilities.
Parallel Funds Onshore and offshore are not linked and do not share liabilities
Pros: 1) two funds can have different fiscal year cycles which allow to stagger performance fees; 2) separate taxation treatments; 3) as
separate entities, two funds don't share liabilities
Cons: 1) high fees charged by PBs as being treated as two separate entities; 2) additional resources required to maintain a high level of
accounting, operating and compliance procedures
Master-feeder Funds Both onshore & offshore funds link to the master fund which is the legal entity bearing all liabilities
Pros: 1) cheaper fees charged by PBs than parallel funds for being treated as a single fund; 2) easier than parallel funds to maintain
Cons: disadvantage to tax-driven transactions and potentially more complex legal issues due to shared liabilities

Side Pockets
Terms
Setup
Asset ownership – who owns what
Ascertain if there is a set % of a fund’s total AUM can be allocated to a side pocket
Policy – 1) types of asset can be included in a side pocket; 2) procedures for transferring assets both in and out
of a side pocket
Fees Ascertain how management fees and performance fees are calculated for a side pocket
Valuation
Ascertain if assets in a side pocket are valued internally or by a third-party
Review the policy on how assets are valued in a side pocket and the valuation frequency
Compliance
Review the disclosure policy on a side pocket, particularly regarding its creation, maintenance and exit
Review the record of all transactions that have taken place within a fund’s side pocket(s)

References – 1
71
• AIMA. (2016). AIMA's New Investor Relations Guide. Retrieved 2020, from https://thehedgefundjournal.com/aima-s-new-investor-relations-guide/
• Arguello, J., & Newman, J. (2015). The science and art of manager selection: Wealth Management, Manager research at Barclays. Retrieved 2020, from https://www.barclays.co.uk/wealth-management/news-
and-insights/investments/manager-selection/
• Chait, N. (2001, February 01). Manager selection – process of elimination. Retrieved 2020, from https://www.ipe.com/manager-selection-and8211-process-of-elimination/13926.article
• CORGENTUM CONSULTING. (2012). Family Office Study: Taking Aim At Hedge Fund Operational Risk. Retrieved 2020, from
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