Six Principles of Operational Due Diligence

Hedge funds have progressively moved into the mainstream of institutional investing.  While even ten years ago, hedge funds were still largely the “secret club of the super rich,” sophisticated investors such as pension funds, sovereign wealth funds and large endowments now embrace the absolute return and diversification benefits available from hedge funds.  Retail investors are also exposed to hedge funds as never before: many corporate pension schemes have added hedge fund exposure, and more generally, the movements of both stock and bond markets are now heavily influenced by hedge fund investment decisions and capital flows.  Since the 2008 market crisis – thanks in part to Bernie Madoff, Lehman and numerous funds gating and suspending redemptions – operational due diligence has become much more significant to the hedge fund selection process.  See “What Are Hybrid Gates, and Should You Consider Them When Launching Your Next Hedge Fund?,” Hedge Fund Law Report, Vol. 4, No. 6 (Feb. 18, 2011).  While performance and strategy remain central to every decision to allocate to a fund, investors large and small must also ensure that they have selected a manager with sufficient controls and infrastructure to safeguard assets.  In a guest article, Christopher J. Addy, President and CEO of Entreprise Castle Hall Alternatives Inc., focuses on several more qualitative aspects of the hedge fund due diligence process, highlighting six principles which can guide the development of an effective due diligence function.

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