First things first – a Happy New Year from all at Inflection Point Intelligence! (See what we did there? Yes, it’s the Year of the Rabbit!)

We kicked off last year with the first official networking event in London in three years, the dawn of an age of “getting back to normal”. Little did we suspect that the disruption of COVID would be replaced by the disruption of train strikes. It was 3 strikes for us, as 3 different cocktail events got struck down… Let us all hope that the Year of the Rabbit brings us its lucky rabbit’s foot and we finally get back in the swing of things.

Our events remain a great benefit for participants of both our hedge fund course (the Henley Executive Hedge Fund Program) and the family office program (the Henley Family Office Program )– they are always a great chance to make new connections and reconnect with old ones. Members of the IPI Professional Network receive invitations too – if you’re not a member, sign up at https://www.ipi-edu.com/What-Is-The-IPI-Professional-Network or contact us at info@ipi-edu.com.

Hong Kong fared better – as the last of the COVID restrictions were lifted, Anna was able to make her first trip to Hong Kong in over 3 years and finally met Peony Mu and Bella Ng, our Business Development team. We also held our first networking event of 2023 with Anna there as our special guest - check out the Photo Gallery to see pictures!

Anna was also invited by The Association of Family Offices in HK to join a panel at the Asian Futurists Leadership Forum. The topic concerned what private investors look for when they do due diligence on Hedge Funds, and how their requirements differ from those of institutional investors. Of course, this was a terrific topic as it brings together hedge funds and family offices, our favourite topics.

Here's a recap of what Anna talked about:

If you’re looking for a hedge fund, that generally means you’re looking for uncorrelated returns or alpha, and that means you’re looking for a Portfolio Manager with an “edge”. You’re also looking for a Portfolio Manager who has cut themselves free from the confines of big financial firms to do their own thing as an entrepreneur.

But (as we teach in our hedge fund certification course) you’re also looking for someone who is going to take fiduciary responsibility for your money.

And here’s the rub – people who are good at making money, and people who are entrepreneurs, are by their very nature risk takers. And risk takers are, in general, not the kind of people who are good at disciplined infrastructure, controls and people management.

Take a look at Sam Bankman-Fried as an example. A big thinker, a visionary, someone who built a very successful hedge fund – but apparently someone who had no idea how to (or perhaps no desire to) implement controls over a financial company.

And so, it’s very important to understand that you are buying not only the Portfolio Manager but also the rest of the team members, plus the infrastructure. Doing due diligence on the infrastructure is called Operational Due Diligence, and it’s far less frequently mentioned than Portfolio Due Diligence. Fundamentally it’s a vital deep dive into the non-investment, operational side of things, looking for two things - most dramatically, looking for fraud (for example, a Bernie Madoff-type scenario), and more mundanely looking for operational weakness (the opposite of operational alpha). Most failed hedge funds go under because of operational risk, not strategy-related issues.

So key due diligence item #1 is: Look at the whole team

How strong is the COO, who is looking after the non-portfolio side of things? How strong is the risk manager? Can they stand up to the PM and can they take off a position if it’s too risky?

Key due diligence item #2 is: Look at Controls.

Separation of duties is non-negotiable. The Fund Administrator MUST have dual control over any money leaving the closed system of the fund’s bank and brokerage accounts.

Also, reconciliations of the fund’s books and records with the bank and the prime broker must be done regularly, preferably daily, by non-Portfolio Management staff.

Key due diligence item #3 is: Look for Conflicts, particularly around Valuations

You need to be sure that the custody and the valuation of the fund’s assets are done independently of the PM.

Key due diligence item #4 is: Ensure there is proper Governance

Independent oversight of the fund is also non-negotiable. There should be at least one independent director on the fund’s board. They should be experienced in financial services and should not be related to any executives of the fund.

We cover all these topics with experts in our hedge fund course.

In order to do this kind of review, it’s important to implement a robust process. Generally, that comes in four steps.

ODD Step 1 is to review the fund’s documentation – everything from the legal documents to the operational procedures. The first thing to ask for is the Due Diligence Questionnaire, which is a list of responses to standard questions about the fund and how it operates. Any respectable fund will have that ready prepared.

ODD Step 2 is an onsite review – to see the offices, check they actually exist, and meet the team including more junior people to see that they are genuine and understand their roles.

ODD Step 3 is to check Service Providers.

Anyone who looked at Bernie Madoff’s Auditor (an obscure 2-man shop) and Fund Administrator (there wasn’t one) would have immediately understood that something was wrong with that setup. You can listen to the story of how one potential investor in Bernie Madoff’s fund identified the red flags and stayed away from danger, in Speaker Series Video #25 here - https://www.ipi-edu.com/members-only-video-library.

ODD Step 4 is to get background checks done by a professional firm. You need to know who you are dealing with, and any financial vulnerabilities or unsavoury connections or backgrounds they may have.

So that’s the process before you invest, and you need to look at the same things every year too – just because there’s nothing wrong in 2023 doesn’t mean something won’t be wrong in 2024.

And finally – is conducting ODD different for family offices from doing it for institutions? It really isn’t. The problem is the effort that is required, and the access the fund will grant.

A full Due Diligence can take six months or more of investigative work, and can only really be done by large institutions with dedicated teams, making sizable investments.

One strategy for smaller investors has been to rely on the presence of big investors, as a guarantee that Due Diligence has been done. However, we have the very recent examples of Temasek and Softbank investing in FTX – so you can’t rely on the big fish not to be taken in.

Alternatively, you can go to a specialist firm, like Albourne Partners, who do this for a living.

Another option is to invest through a fund of funds – these charge higher fees, but the higher fees cover this kind of effort.

Ideally, any family office education programs would cover these kinds of topics. With Inflection Point Intelligence’s Family Office Program, participants have access to the Operational Due Diligence module of the Henley Executive Hedge Fund Program which covers these points and more.

For further information, please contact Lisa So at lisa.so@ipi-edu.com.