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FRM Part II · FRM Exam Part II · Performing Due Diligence on Specific Managers and Funds

A due diligence team compares a hedge fund's reported performance with its stated strategy of long/short equity with net exposure between 0% and 30%. The fund reported positive returns in every month for six years, including months when the equity market fell more than 8%. Which is the most appropriate next step?

The team should obtain position-level data and independent confirmation from the prime broker and administrator to reconcile reported returns with actual holdings. Perfectly smooth returns in falling markets are inconsistent with a low-net-exposure equity strategy, so independent verification matters more than the manager's own explanation.

  1. AAccept the track record because the fund is within its risk limits
  2. BRequest position-level data and independent confirmation of trades and holdings from the prime broker and administrator to reconcile with reported returnsCorrect
  3. CIncrease the allocation because low volatility improves the Sharpe ratio
  4. DRely on the manager's explanation of proprietary hedging techniques

Explanation

Returns inconsistent with strategy and market behavior require independent verification of holdings and trades. Relying on the manager's explanation or on the attractive Sharpe ratio ignores the possibility of fabricated or misreported returns.

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