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

A fund of funds is reviewing a single-manager hedge fund whose founder is also the chief investment officer, chief risk officer and sole member of the valuation committee. The fund's board has two directors, both affiliated with the manager. Which governance concern is most significant?

The key concern is the lack of independent oversight and segregation of duties. One person controls investing, risk and valuation, and the board is not independent, so nobody can challenge prices or risk limits. This creates the conditions for mispricing and misconduct.

  1. ALack of independent oversight and segregation of duties over valuation and riskCorrect
  2. BThe fund's concentration in a single strategy
  3. CThe absence of a high-water mark in the fee structure
  4. DThe use of a Cayman Islands domicile

Explanation

One person controlling investment, risk and valuation, with a non-independent board, removes checks over pricing and risk limits, which is the core operational risk red flag. Domicile is common and not by itself a concern, and fee terms and strategy concentration are separate issues that do not address oversight.

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