Why invest in a private fund?
Private funds have historically provided strong risk-adjusted returns – but not 100% of the time. Sometimes investors experience large losses and, contrary to popular belief, not solely due to poor performance. According to a Capco study, 50% of hedge fund failures are due to operational, legal, and business risks. Identifying the best fund managers and then completing proper due diligence are essential steps to mitigate the risk of selecting the wrong one.
How comprehensive is typical investor due diligence?
Investors seem to display a certain apathy towards completing operational due diligence. In the last 12 months Opus has processed 3,889 new investors into our fund clients. However in that time, we only participated in just 46 operational due diligence exercises. Those that did ask questions differed greatly. Some ask us to confirm our appointment. Others complete comprehensive investigations, hiring third-party experts, taking several months to complete. Many investors only perform due diligence at the initial subscription stage, but do no further periodic reviews.
What causes investor indifference to completing proper due diligence?
Investors face many challenges. The industry is inherently opaque, and fund managers have little incentive to divulge more information than they absolutely must. Managers compete for alpha, so fund specific information could impact their competitive advantage. Further, due diligence takes time and effort and requires experience to evaluate business and operational risks. It’s easy to rely on others such as the auditor, administrator, regulator, or other investors, to identify issues for you. And when investors do perform a review, it’s mostly when initially selecting the manager. But things change and updates are needed regularly. Investors lack the time and experience to properly complete the process. But when investors fail to complete their own review, they subject themselves to unnecessary risks.
What reliance can be placed on the fund service providers?
Regulators have recently increased expectations on service providers, even coining their role as “gatekeepers”. This has resulted in administrators being subject to a major expectations gap between services engaged to perform, and what investors and regulators think they should do. Fund managers exert significant control over choosing the exact services to be performed, leaving the administrator performing little more than a data processing function. When risks exceed acceptable tolerances, confidentiality provisions within the administration agreement limit what an administrator can do. Leaving resignation, or in extreme cases whistleblowing as its only course of action. But by then, the investor may already have incurred significant losses. Losses that could easily have been prevented by performing proper ongoing due diligence.
How can the fund administrator help with due diligence?
When empowered to do so, the administrator can play a key role aiding transparency and due diligence by supplying more information. The best example is the Administrator Transparency Report (ATR). An ATR provides a wealth of important information such as exposure to single counterparties, levels of illiquid assets, pricing sources and importantly, those supplied by the fund manager. However, the ATR is not issued by default. Investors must request an ATR, and the fund manager must authorise the administrator to release.
Opus offers ATR+, how does this differ from a normal transparency report?
The standard transparency report has inherent flaws which reduces its value. It provides limited information at a single point in time and needs to be regularly updated. ATR+ takes transparency to the next level. It provides approximately 80 data real-time data points and is automatically updated. It can be accessed via the Opus Investor Portal, is always available, easy to find, and affords real time risk monitoring. Yet possibly its biggest strength is the way it delivers multi fund information via a single screen. This allows the user to compare data points across multiple investments to assess aggregated information. For example, what is your exposure to a single custodian? Or why is the administrator involved in the wire process for six of my investments, but not the seventh? And arguably its biggest strength is that it is administrator agnostic. ATR+ can display information from any recognised third-party source.
Any final thoughts?
Institutional investors understand that blaming service providers when losses occur, whilst taking no steps to mitigate the risks, is unacceptable. And forward-thinking fund managers understand that providing improved transparency is a competitive advantage, not a weakness. A robust investor due diligence process helps raise more capital and then retain it for longer. The industry is moving towards encouraging more due diligence, and ATR+ is a key tool to help investors limit exposure to unnecessary risks.