Hedge Fund Operational Due Diligence: Understanding the Risks [NOOK Book]

Overview

Praise for Hedge Fund Operational Due Diligence: Understanding the Risks

"This book should be required reading for anyone who wants to successfully invest in hedge funds. As operational problems are reputed to cause over 50% of all hedge fund failures, it is essential that hedge fund analysts understand how to conduct proper operational due diligence—many firms are only now starting to understand the importance of this skill set. Mr. Scharfman's book will go a long way towards ...

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Hedge Fund Operational Due Diligence: Understanding the Risks

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Overview

Praise for Hedge Fund Operational Due Diligence: Understanding the Risks

"This book should be required reading for anyone who wants to successfully invest in hedge funds. As operational problems are reputed to cause over 50% of all hedge fund failures, it is essential that hedge fund analysts understand how to conduct proper operational due diligence—many firms are only now starting to understand the importance of this skill set. Mr. Scharfman's book will go a long way towards educating analysts in this critical area."
—Ed Rogers, CEO, Rogers Investment Advisors, LLC

"Scharfman has written an excellent book! Highly accessible . . . covers crucial topics! This book should be read by all analysts who cover the hedge funds space. It also furnishes a very valuable and necessary addition to the MBA finance curriculum. Solid operational infrastructure is exactly what the smart institutional investors are demanding, and rightly so. Scharfman's book is going to help make a lot of good decisions—that is, for those who are prudent enough to read it."
—Dr. Ranjan Bhaduri, Managing DirectorAlphaMetrix, LLC

A straightforward how-to guide for conductingeffective hedge fund operational due diligence

Providing a hands-on, step-by-step guide to the operational due diligence process involving hedge funds, Hedge Fund Operational Due Diligence: Understanding the Risks addresses essential issues including:

  • Why you should care about operational risk
  • Who is qualified to perform an operational risk review
  • How you can easily create an initial operational profile
  • The gray areas of operational due diligence
  • Ten tips when performing an operational due diligence review
  • Techniques for modeling operational risk

Packed with insight and tips to help you diagnose and monitor key hedge fund operational risks, Hedge Fund Operational Due Diligence: Understanding the Risks is required reading for every hedge fund analyst and investor.

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Editorial Reviews

From the Publisher
"Informative book by Jason Scharfman, on, well, pretty much everything you need to run a hedge fund…Scharfman also explains the reliance on technology that is becoming ever more apparent in hedge funds, the dangers of phantomware, and questions that should be asked before committing to any new technology." (hedgeco.net, January 26th, 2009)

"In his book, Jason Scharfman identifies these operational risks and recommends a strong and innovative "operational" due diligence review program as the best defense against them. His book outlines a step-by-step guide that shows investors how to effectively detect and evaluate often-overlooked operational risk factors in hedge funds and other investments in order to provide hedge funds and their investors with the skills to understand and hopefully mitigate these risks." (The Hedge Fund Law Report, January 8, 2009)

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Product Details

  • ISBN-13: 9780470466179
  • Publisher: Wiley
  • Publication date: 12/3/2008
  • Series: Wiley Finance , #523
  • Sold by: Barnes & Noble
  • Format: eBook
  • Edition number: 1
  • Pages: 320
  • File size: 3 MB

Meet the Author

JASON A. SCHARFMAN is a Director with Graystone Research at Morgan Stanley. His responsibilities include analyzing and reporting on the operational risks of alternative investments such as hedge funds, funds of hedge funds, and private equity considered for investment. He also makes recommendations to the firm's investment committee based on that analysis. He has written on the subject of operational due diligence and travels and speaks worldwide on hedge fund operational risks.

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Table of Contents

Preface.

Chapter 1. What is Operational Risk?

Brief History.

Modern Definition of Operational Risk in a Hedge Fund Context.

Operational Due Diligence versus Operational Risk.

Key Areas.

External Risks.

Internal Risks.

Fund Terms.

Transparency and Reporting.

Blended Risks.

The Five Themes.

Chapter 2. The Importance of Operational Due Diligence.

Why Should Investors Care About Operational Risk?

Morton's Fork Or A Hobson's Choice?

Outright Fraud Still Exists.

Hedge Fund Fraud Cannot Be Modeled.

Small Discrepancies Add Up.

Lack Of Standardized Regulation.

Each Hedge Fund Is Different.

Ability To Generate An Informational Edge.

Potential To Reduce Losses And Increase Returns.

Considering Operational Risk Factors Presents A Different View Into A Firm.

Common Misconceptions.

Other Considerations: There Is Not Necessarily A Positive Correlation Between Assets And Operational Quality.

A Study In Operational Failure: Bayou Hedge Fund Group.

Affiliated Broker Dealer.

Large Discrepancies Between The Performance Of Onshore And Offshore Funds.

Declining Capital Of Broker Dealer.

Board Of Directors: Members And Actions.

Lavish Expenses Of Broker-Dealers.

Fake Audits Prepared By A Phony Auditor.

Background Questions.

Lack Of Investor Communication.

Ties To People Barred From The Securities Industry.

Revision Of Conflicted Marketing Materials.

Other Anomalies.

Chapter 3. Who Is Qualified To Perform An Operational Due Diligence Review?

Essential Skills.

Primary Skills.

Primary, Secondary, Blended, And Other Skills.

In-House Versus Outsourcing.

Evolution Of Independent Operational Rating Agencies.

Benefits Of Third-Party Rating Agencies.

Criticisms Of Third-Party Rating Agencies.

Factors To Consider Before Performing An Operational Review Of A Hedge Fund.

Chapter 4. Creating An Initial Operational Profile.

When Does An Operational Due Diligence Review Begin.

Documentation.

The Piñata Problem.

Due Diligence Questionnaire:  To Use Or Not To Use?

Background Investigations.

Other Considerations.

Importance Of On-Site Visits.

Which Office To Visit?

Manager Interview Process.

What Topics Should I Cover During An On-Site Review?

Sample Topic Questions.

In What Order Should These Topics Be Covered?

Service Provider Reviews.

Qualitative Operational Report: Documenting The Operational Data.

Chapter 5. Evaluating the Gray Areas: Examples.

Scenario 1: It Was Not Me–Hedge Fund Manager Claims It Is Mistaken Identity.

Scenario 2: It Was Me But, Everyone Was Doing It–Are Regulatory Witch Hunts Real?

Scenario 3: It Was Me But, I Did Nothing Wrong--Manager Proved Not Guilty.

Scenario 4: The Low Profile Hedge Fund Manager–Is No News Good News?

Scenario 5: The Infrastructure Outsourcer–Can An Administrator Do Everything?

Scenario 6: The Mountain Climber – Can Plans For Large Fast Growth Trip You Along The Way?

Scenario 7: The Stumbling Giant–Can A Large Manager Lose Sight Of Small Controls?

Scenario 8: The Apologetic Headmaster–Are Junior Staff As Informed As Senior Management?

Chapter 6. Ten Tips When Performing an Operational Due Diligence Review.

Tip 1. Meeting With The Wrong People Or The Wrong Groups.

Tip 2. Get Out Of The Conference Room.

Tip 3. Little White Lies Can Turn Into Big Problems.

Tip 4. Be Wary Of Phantomware.

Tip 5. Focus On Documentation And Negotiation.

Tip 6. Read The Fine Print (Financial Statement Notes Etc.).

Tip 7. Reference Checking: The Importance Of In-Sample And Out Of Sample References.

Tip 8. Credit Analysis: Are Funds Financially Viable?

Tip 9. Long-Term Planning: Key Staff Retention, Succession Planning, And More.

Tip 10. Growth Planning: Is The Manager Pro-Active Or Reactive??

Chapter 7. On-going Operational Profile Monitoring.

How Often Should Background Investigations Be Renewed?

Remote Operational Due Diligence Monitoring.

Media Monitoring.

Litigation And Regulatory Monitoring.

Hedge Fund Communication Reviews.

Assets Under Management And Performance Monitoring.

Operational Events.

Effect Of Discovery On The Magnitude Of An Operational Event.

On-Site Visit Frequent And Operational Events.

Developmental Operational Traps.

Multi-Jurisdictional And Intra-Jurisdictional Regulatory Coordination.

Silo Creation.

Organizational Nesting.

Chapter 8. Techniques For Modeling Operational Risk.

Scoring Systems.

Building a Scoring System: Category Determination.

Category Definitions.

Category Definitions: Combinations of Approaches.

Category Weight Assignment.

Weighting Aggregation Model.

Weighting Disaggregation Model.

WAM versus WDM.

Category Weight Consistency and Re-weighting Considerations.

Factor marginalization.

Category Scale Determination and The Meaning of Scores.

Threshold Self-Assessment and Determination.

Score Assignment.

Discretionary Penalties and Bonuses.

Discretionary Magnitudes.

Score Aggregation: Sum Totaling and Weighted Averages.

Criticisms of scorecard models.

Benefits of scorecard models.

Visualization Techniques.

TreeMapping.

Chapter 9. Bridging the Gap: Incorporating Operational Risk Consideration Into the Portfolio Construction and Asset Allocation Process.

Pro-Active Monitoring: Graphical Universe Creation.

Pro-Active Management Of Operational Risks.

Protecting Against Conglomeration Risks: Multivariate Commonality Analysis.

Operational Directional Views.

Example Of Multivariate Commonality Analysis.

First Objective: Total Diversity Goal.

Second Objective: FSA Overweight Goal.

Third Objective: FSA Underweight Goal.

Conclusions Of Scenario Analysis.

Considering Operational Reviews In The Hedge Fund Portfolio Rebalancing Process.

Operational Drag.

Meta Risks.

Operational Factor.

Operational Scenario Analysis.

Can Operational Risk Be Entirely Eliminated?

Factoring Operational Risk Into Total Risk Calculations.

Beyond Scorecard Approaches: Discounting Expected Return.

Discounted Expected Returns With The Operational Factor.

Operational Haircuts.

Expected Return And Operational Risk.

Shape Of The Expected Return Versus Operational Risk Curve.

Second Operational Threshold.

Final Thoughts.

Chapter 10. Looking Ahead: Trends in the Space.

Increased Use Of Consultants.

Commoditization Of Background Investigations And Canned Operational Due Diligence Reports.

Increased Reliance On Service Provider Consulting Services.

Capturing Of Hedge Funds By Service Providers And Employees.

Hedge Fund Pursuit Of Audit Certifications.

Operational Activism.

AU 332 And FAS 157.

Development Of Hedges To Operational Risks.

Links Between Operational Risk And Credit Analysis.

Proposed Re-Regulation Of The Hedge Fund Industry.

Index.

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Customer Reviews

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Sort by: Showing all of 19 Customer Reviews
  • Posted February 7, 2009

    Best hedge fund book out there today

    I recently finished reading this and I can honestly say, having worked in the industry for a few years now, that this is the most comprehensive guide I've come across. I enjoyed not only the author's frankness and but level of detail he provided. Really useful and in todays world should be required reading for all hedge fund investors, professionals and regualtors (including the SEC!). Really useful due diligence resource!

    9 out of 9 people found this review helpful.

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  • Posted February 10, 2009

    A hedge fund must read!

    I didn't think this book could possibly be as good as everyone said it was but I was really impressed - It's actually that good and more!<BR/><BR/>The author really takes time to provide a very detailed analysis of this subject. I am new to working in the hedge fund industry and wanted a book that would give me a good overview not just on strategy names etc. but operations, what investors look for and some perspective. This book gave me all that and more. Very good technical explinations but also an interesting read, particularly the chapter on the gray areas of hedge fund investing. I really do recommend this!

    8 out of 8 people found this review helpful.

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  • Posted February 9, 2009

    Detailed and insightful

    Enjoyed this book and would highly recommend. A good read across many levels. Very detailed analysis of the subject and unique insights into the hedge fund industry.

    8 out of 8 people found this review helpful.

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  • Posted February 5, 2009

    Excellent resource!

    I found this book to be a great comprehensive resource for me on the subject of hedge fund due diligence. I have read a lot of hedge fund books and I honestly have to say this is the best one out there. Finally an author who gets it! Particularly enjoyed the examples and depth of coverage of this subject. Recommend this to all investment professionals.

    8 out of 8 people found this review helpful.

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  • Anonymous

    Posted January 23, 2009

    Excellent and very on-point

    I really enjoyed this book on many levels. <BR/><BR/>For starters, I liked the way the author took the time to explain the history of what exactly operational risk was. The due diligence framework he lays out was extensive and very detailed yet easy to follow. I liked the way hypothetical examples were provided which really helped me to understand some of the finer points of operational due diligence topic.<BR/><BR/>It was interesting to get the opinion of someone who had done this for a living like the author had rather than someone who is just an academic. The way he writes about everything he writes about makes a lot of sense. <BR/><BR/>A very good read!

    8 out of 8 people found this review helpful.

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  • Posted January 12, 2009

    Very interesting read!

    I found this book to be a very interesting and topical read. I found the sections regarding the gray areas to be very well thought out examples which helped me understand the subject.<BR/><BR/>I am an MBA student who is interested in learning more about hedge funds and this helped a lot. <BR/><BR/>I would recommend this to everyone interested in learning about hedge funds and due diligence.

    7 out of 7 people found this review helpful.

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  • Anonymous

    Posted February 13, 2009

    Great compliment to CAIA cirriculum

    I work at a hedge fund and I will taking the Charered Alternative Investment Analyst Association (CAIA) in March and found this book to be a nice compliment to the hedge fund cirriculum (most of which was a bit dry) - but this book was actually a really manageable read. The examples were also very useful and I really like the practicioners perspective the author provides. Recommend this to my fellow CAIA candidates!

    6 out of 6 people found this review helpful.

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  • Posted February 11, 2009

    Useful book!

    I am studying for the CFA exam and found this book to be a very useful read for me. Really enjoyed getting a practicioners perspective on how this due diligence process is supposed to work and helped me to frame put some of my other hedge fund knowledge in perspective. Recommend this to all studying for CFA

    6 out of 6 people found this review helpful.

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  • Anonymous

    Posted February 16, 2009

    Very timely read for me

    I agree with the other reviewers. Very interesting good book. I also used ths to prepare for CAIA - and liked it too.

    4 out of 4 people found this review helpful.

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  • Posted February 15, 2009

    Great Hedge Fund Guide

    I am a financial advisor and have started to put my client's money in alternatives. This book gave me what I was looking for, a good guide to the due diliengence process. I found many of the techniques described to be applicable not just to hedge funds but private equity, venture capital and real estate investing as well.<BR/><BR/>I also liked the author's concept of Operational Drag. Very interesting read.

    4 out of 4 people found this review helpful.

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  • Posted February 21, 2009

    Gave me a great subject overview

    This book was exactly what I was looking for: (1) good subject overview BUT, (2) detailed enough to be actually useful.

    Really topical and will be a good on-going desk reference on hedge funds for me.

    Happy reading!

    2 out of 2 people found this review helpful.

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  • Posted April 1, 2009

    Interesting, informative and very topical - I liked it!

    I have to start off by saying that I am generally not a big fan of these types of books - but this was a happy exception and I really enjoyed this! I work in compliance and with all the news about hedge funds I wanted to learn more (thinking of getting into fraud investigation field). This book gave me a nice overview of a subject I really new nothing about - it was an easy read and was not short on technical details which I liked too. The examples really helped to. I recommend this to basically anyone who wants to learn more about hedge funds - worth a read.

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