The Hedge Fund Book by Richard C. Wilson

Author:Richard C. Wilson [Wilson, Richard C.]
Language: eng
Format: epub
ISBN: 9781118107973
Published: 2011-03-27T16:00:00+00:00

Chapter 6

Dedicated to Due Diligence

It is the studying that you do after your school days that really counts. Otherwise, you know only that which everyone else knows.

—Henry Doherty

(This chapter was written by Gregory Schink, a wealth management professional who helped lead the efforts to create the CHP Designation Level 2 Program on due diligence.)

From the late 1990s through the third quarter of 2007, investors felt an overwhelming confidence in the validity of the investments they were selecting, and more especially the managers who ran them. Bernard L. Madoff Investment Securities had been brought up to the SEC for possible violations since as early as 1999. The SEC was alerted to possible fraud concerning Sir Allen Stanford as early as 2002. The credit crunch of 2007 was what finally brought these frauds to light.

The possibility of fraud going undetected on such a massive scale has caused a revolution in how in-depth due diligence will go when investigating a hedge fund and its manager(s) for potential investors. The days of run-and-gun investing when investors were chasing the highest returns possible (think Long Term Capital Management) are gone. Hedge funds must be crystal clear on their backgrounds, the processes they use, and the style they intend to implement. This is helping bring hedge funds more into the mainstream and change the public's opinion of how secretive they have appeared in the past, as well as making quality due diligence a must for high net worth (HNW) investors looking to invest in the hedge fund arena.

Why important: Due to recent scandals, media attention, fraud, and insider trading cases, due diligence is one of the most important topics in the industry. This is because due diligence is the forum through which fund managers may communicate their transparency, proactive institutional-quality operations, and robust investment process. It is also important because it is the method through which accredited and institutional investors attempt to avoid funds that may be more likely to be involved in scandals, fraud, blowups, or insider trading cases. If you are not aware of best practices and trends in the due diligence space, you may miss opportunities to manage risk or obtain additional capital.

In this chapter, the interviews Gregory completed with two prominent experts in the due diligence arena and Richard Wilson consisted of a series of questions to gain a further understanding of their experience in the due diligence field. The questions include personal background questions such as what is the preferred background for someone who wishes to start a profession in the due diligence arena concerning hedge funds; and what's the best advice you can give to someone starting out in due diligence. We also examine some due diligence best practice tips that each interviewee has, such as some telltale signs of a shady manager/fund, and what resources a hedge fund manager should have in place in order to efficiently move through a due diligence questionnaire (DDQ) process more efficiently.

Through each interview, we present three different backgrounds, opinions, and approaches to successful due diligence.

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