When choosing hedge fund managers, institutional investors need to emphasize operational risk processes, a new Bank of New York report says.
The report, titled “Hedge Fund Operational Risk: Meeting the Demand for Higher Transparency and Best Practice,” says a recent jump in investments by institutional investors and the quick maturation of the industry’s infrastructure has upped investors’ need to assess the operational systems of potential hedge fund providers.
The report, which was launched in conjunction with Amber Partners, outlines five areas of operational procedures that, it says, pose the greatest risk to investors.
The first concern to investors, the report says, ought to be the person in the role of CFO or COO. A mistake here could lead to disastrous consequences, but an experienced CFO can be a great asset to a fund, even if some office functions have been outsourced. Alongside the CFO, it continues, there should be a settlement and operations staff relative to the size and complexity of the fund.
The report also says firms should have clear compliance manuals that outline policies regarding personal trading, trade errors and know your customer checks among others.
Other key areas to focus on are internal controls and procedures, independent portfolio pricing and the quality of service providers.
“Investors must increase their focus on assessing the operational risk aspect of their investments and not wait for either the regulators or an unexpected problem to surprise them,” says David Aldrich, head of securities industry banking, The Bank of New York. “They also need to bear in mind that good operational due diligence will help them avoid funds which may suffer a drag on performance due to weak controls, frequent errors and poor internal information. Investors who consider operational factors will make better informed investment decisions and receive more secure returns.”
The report will be formally released at Hedgestock which is taking place at Knebworth House, UK June 7 and 8.