Family offices warned on operational due diligence shortcomings
Family offices and endowments, increasingly returning to direct hedge fund investing, need to make wholesale improvements to their operational due diligence processes.
“In general, family offices, foundations and endowments are under pressure to keep their overheads as low as possible. Consequently they often do not have the resources necessary to conduct effective operational due diligence. These investors often rely on their consultants or other internal staff to conduct operational due diligence processes on hedge funds. Many - however - are not in depth enough,” said John Ward, head of operational due diligence at EIM, the fund of hedge funds recently acquired by Gottex.
A study by Corgentum, a New Jersey-based operational due diligence consultancy, found a quarter of family offices did not perform any operational due diligence on their investments. Seventy-three per-cent told Corgentum they did not feel confident in their own operational due diligence procedures, saying they lacked training and knowledge. A staggering 79% of family offices do not document their operational due diligence procedures.
This is particularly worrying because family offices tend to invest in emerging managers – firms which tend to carry the highest operational risks. Eighty per-cent of family offices told a Barclays Prime Services they would invest in a hedge fund with less than a one year track record, while half would seed a day one manager. A J.P. Morgan study in May 2013 revealed 37% of family offices would increase the number of start-ups in their portfolio, while 86% said they would invest in sub-$100 million hedge fund managers.
“Family offices need to bolster their operational due diligence teams. There are a lot of talented operational due diligence professionals out there, and family offices need to hire more staff to undertake operational due diligence,” said Ward.
Family offices are also notoriously aggressive performance chasers with 60% of single family offices telling the Barclays study their investment mandate was focused on growth as opposed to capital preservation. This was also evidenced in Deutsche Bank’s 2013 Alternative Investor Survey, which showed family offices had return expectations of 10.1% - the highest among all hedge fund allocators. These hedge funds, much like emerging managers, tend to be higher risk and often require more intense operational due diligence.