FRM Part II · FRM Exam Part II · Performing Due Diligence on Specific Managers and Funds
An allocator is beginning due diligence on a single-manager hedge fund. Which sequencing of work best reflects a sound due diligence framework that separates investment due diligence from operational due diligence?
Investment and operational due diligence should be run as independent workstreams, with the operational review able to veto an allocation even if the investment case is strong. Operational failures and fraud drive many hedge fund losses, and independence avoids conflicts from the investment champion or the fund's own service providers.
- ARun investment and operational reviews as independent workstreams with the operational review able to veto an allocation regardless of the investment caseCorrect
- BComplete the investment review first and conduct the operational review only if the manager's returns are attractive, to save cost
- CDelegate operational review entirely to the fund's administrator, since it holds the books and records
- DLet the portfolio manager who champions the fund lead both reviews to ensure consistency
Explanation
Sound frameworks treat operational due diligence as independent of the investment team, with authority to reject a fund even when the investment thesis is strong. Relying on the administrator or the champion creates conflicts of interest. Deferring operational work understates its importance, since many hedge fund failures are operational.
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