Example of Our Hedge Fund Due Diligence Process

The aim of the Due Diligence process is to build up an understanding of the strategy and risk involved.This is a step-wise process that requires several interaction with the portfolio manager and his team.

The client may wish to focus only on funds of some  strategies or that are compliant with specific tax requirements.

 When: t+0 

The client would like to focus the research on macro funds that are German Tax Transparent.

The screening will be subordinated to the constrains discussed in the initial meeting. Funds with strategies that are out of scope are excluded at this stage.

 When: t+1 week

The screening will be subordinated to these constrains. Funds with strategies that are out of scope are excluded at this stage.

A full set of documents is screened: past newsletters, presentations, DDQ, financial statements. Usually the funds that do not pass this stage have some flaws in their strategy, most likely in their set-up or investment approach.

 When: t+2 months

In the marketing documents, the fund displayed a 5 year track record (inception 2007). This is however a composite track record of 2 distinct products, the actual fund was launched in Feb 2011. Financial statements, presentations and reports related to the constituent funds were analyzed and discussed during a conference call. Green light for the strategy and setup, but decided to keep the fund screened for a few more months.

The investment method and most relevant risk management are discussed together with the portfolio manager during an on-site visit. Clients that do wish so are welcome to join the on-site meetings. Additional reports might be discussed with the fund manager.

 When: t+3 months 

The portfolio manager reviewed the risk management guidelines and answered questions regarding the models used to run the fund. The operational setup was only marginally discussed as it was fully analyzed during the previous months, both verbally and in a written form together with other components of the team.

Only if the fund meets the investment criteria and if it is a reasonable candidate for investment (i.e. there is a fit in the existing portfolio) the prospectus is analyzed and a report including the main qualitative key-data is drafted.

 When: t+4 months

The findings of the meeting with the manager were in line with expectations and the fund could fit well in the existing portfolio, namely it was a diversified macro. At this point there was no material reason to keep the fund further “on hold”. A report was prepared.

Once a Due Diligence report is drafted it must answer the following questions:

Setup: What is the legal setup and who are the counter parties of the fund? How are the duties shared between the team?
Investment Approach: What is the idea behind the strategy, how is it supposed to be profitable?
Risk management: What is the idea behind the strategy, how is it supposed to be profitable?
Transparency and disclosure: What is the attitude of the portfolio manager to the investors? Is he eager to provide additional transparency if requested? Is he available to communicate directly with the investors?

Fund selection: Conclusion

The type of questions and the amount of supplementary information requested are primarily tailored to the fund‘s strategy. Likewise, the final opinion on the fund is based on an extensive overview and on the assessment on how the fund could likely evolve in the future.
The selection of an absolute return fund is a qualitative matter that is not quite reliant on historical statistics.

Caravel Advisory also provides the necessary due diligence and monitor for hedge funds that are already part of an existing portfolio. We call this ongoing monitoring

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