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

An investor is conducting operational due diligence on a small hedge fund. The fund's founder serves as portfolio manager, chief risk officer and chief compliance officer, and the fund's administrator is a firm the founder owns. Which finding is the most significant governance concern?

The founder's holding of several control roles combined with an affiliated administrator is the most serious concern, because it eliminates independent checks on valuation, risk and compliance. This lack of segregation of duties creates fraud and misreporting risk, unlike concentration, short history or a high-water-mark fee.

  1. AThe fund's investment strategy is concentrated in a single sector
  2. BThe fund has a relatively short track record of two years
  3. CThe founder's multiple roles and an affiliated administrator remove independent checks on valuation and controlsCorrect
  4. DThe fund charges a performance fee above a high-water mark

Explanation

Independent oversight of valuation, risk and compliance is a core operational safeguard. Concentrating roles in one person and using an affiliated administrator removes segregation of duties and enables mispricing or misreporting. The other items are investment or fee matters, not control failures.

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