Fund managers should introduce town-hall style ODD visits
Hedge fund managers should consider town-hall style operational due diligence (ODD) visits whereby groups of different investors are invited to perform ODD on their businesses simultaneously in what could streamline the entire process.
“Town-hall style ODD would enable groups of investors to visit a manager at the same time. It would kill several birds with one stone per say. It would save chief operating officers (COOs) an enormous amount of time and effort. Furthermore, if there was a group of investors performing ODD, one would get more breadth of opinion. It is not a catch all but could weed out some investors who do not possess the resources and who simply want an overview of a hedge fund manager’s business,” said one head of operational due diligence, speaking on background.
The concept is also viewed favourably by hedge fund managers. “I think it is a really good idea although I believe it would be better served for on-going ODD as opposed to initial ODD. Operational due diligence is fairly straightforward and 98% of the questions we field from investors are identical. I would have no objection to doing this,” said one London-based hedge fund COO, speaking anonymously.
The initiative could also enable COOs to devote more time and resources to getting to grips with various compliance obligations being imposed on them by regulators globally including the soon-to-be-implemented Alternative Investment Fund Managers Directive (AIFMD), not to mention the European Market Infrastructure Regulation (EMIR), the Foreign Account Tax Compliance Act (FATCA) and Dodd-Frank.
Nonetheless, there are practical challenges, and potential risks. “The big risk would be if the ODD process became commoditised, which could be very dangerous. Some investors - if they were performing ODD among a group of their peers - might be reluctant to ask questions they might normally have asked. Another potential issue could be that some investors might not want their identities to be revealed to their peers,” said the COO.
The ODD head acknowledged this challenge. “Some sort of agreement would have to be reached between investors if they want to perform group ODD, but yes, this might be an issue,” she said.
The idea would probably take off at larger institutional managers, which have no shortfall in clients. Smaller managers are unlikely to have more than one or two prospective investors, rendering group visits obsolete.
While the initiative is likely to prove popular among ODD teams at funds of hedge funds, investment consultants and family offices, it could face stiff opposition from consultancies offering outsourced ODD. “ODD specialists might object to this initiative as it is a threat to their businesses,” said the COO. Nonetheless, the ODD head highlighted specialist ODD firms could still perform one-on-one visits.
The clout of ODD teams within institutional investors has grown exponentially since the financial crisis. A survey by the prime brokerage arm of Deutsche Bank of 68 investors with $724 billion allocated into hedge funds, found 70% of ODD teams had explicit veto authority over hedge fund investments, and this was exercised in almost 10% of manager reviews in 2012.
ODD has become more intense with respondents conducting on average 50 manager reviews per year. A similar study by Deutsche Bank back in October 2012 highlighted 66% of investors took between three and six months to complete ODD on a manager compared with just 33% in 2003. Investors are also conducting rigorous reviews of daily operations on-site at managers, with 60% of ODD teams telling Deutsche Bank this was typical of their ODD process.
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