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

Which due diligence practice best mitigates the risk that a hedge fund manager is fabricating trading records or investor statements?

The best practice is independently confirming assets and trades directly with the custodian, prime broker, and administrator, using contact details the allocator sources itself. This prevents the manager from supplying falsified documents or intermediaries, whereas investor references, peer comparisons, or annual audits alone can be gamed or are insufficient.

  1. AReviewing only the manager's audited financials once a year
  2. BIndependently confirming assets and trade activity directly with the custodian, prime broker, and administrator using contacts obtained by the allocatorCorrect
  3. CAsking the manager to supply references from existing investors
  4. DComparing the manager's returns to a peer group index

Explanation

Direct confirmation with third parties, using independently sourced contacts, defeats fabricated documents supplied by the manager. References from investors, peer comparisons, and annual audits alone can be manipulated or are too limited to detect fabrication.

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