Due Diligence Matters - March 2025
perfORM is an award-winning, international (UK, Switzerland, USA, Hong Kong) and standalone Operational Due Diligence solutions provider with 150+ years of collective ODD experience.
Please contact us if you would like to discuss our services, or to receive sample ODD Reports, thank you.
Audited financial statements review for hedge funds
For investors considering an allocation to a fund, most of the information (DDQs, policies, statistics, etc.) comes directly from the manager without independent oversight or audit. The fund’s administrator provides some level of independence, by offering independent NAVs and verification of cash wire controls, although it is not entirely separate from the manager/fund ecosystem. Although we do not intend to advocate for auditors whose profession and reputation are not without blemish, we believe that audited financial statements (AFS) offer a unique and valuable independent perspective on a fund, enabling us to conduct certain analyses effectively.
For established funds we expect to see AFS issued on a timely basis and unqualified, for both the most recent and previous financial years. AFS for Cayman-domiciled funds, for example, should be issued within six months of year end; if they are not, this could indicate an issue, or complexity, in the fund.
For open-ended funds, the areas most relevant for consideration by a prospective allocator are the condensed portfolio and the ASC 820 disclosure, given the importance of accurate valuations for subscribing and redeeming investors. The ASC 820 disclosure provides insight into the liquidity of the portfolio and should be considered on both a long and short basis; we calculate the proportion of each on a gross basis to ascertain whether the level one (typically exchange-traded), level two (typically priced to broker) and level three (typically marked to model, and therefore illiquid) proportions align with our understanding of the portfolio’s liquidity and the fund’s redemption terms. Likewise, we consider the condensed portfolio to ascertain whether it aligns with our understanding of the fund per the prospectus, or the fund’s internal guidelines. The vast majority of hedge funds reviewed by perfORM report under US GAAP, which is preferable since those reporting under other standards, such as IFRS, may not be required to disclose the condensed portfolio (although IFRS requires an ASC 820-equivalent disclosure under IFRS 7), or an ASC 820-equivalent disclosure, such as Luxembourg GAAP.
The balance sheet provides insight into the fund’s leverage and NAV movement year on year. It can also be used to calculate a two-point average NAV, which can be used to perform reasonableness testing on NAV-related expenses. If our analysis suggests that the movement in NAV has not been steady throughout the year, which is typically the case, we will typically request monthly AUMs for the last two financial years to obtain a more granular average NAV. We can use this to assess the reasonableness of the management fee paid by the fund, as well as whether the proportion of non-investment-related expenses borne by the fund for the last two years are as expected for the strategy. Generally we would expect, for example a systematic fund to have a lower TER than a private credit fund, which is more likely to be subject to legal costs, professional fees etc. Any significant unexplained “other” items may be investigated further. Note that the TER does not include the management fee, as this is an upfront percentage disclosed in the prospectus. As it varies between funds and is typically the largest non-investment related cost, including it would not allow for meaningful comparison between funds.
This review also identifies whether the TER is rising due to a declining NAV and, if so, what the likelihood is of the fund non-AUM-related fees, or minimum fees, more significantly impacting the fund’s performance if the NAV continues to fall.
Although it may be tempting to draw conclusions about the fund’s performance based on the performance fee paid, this is seldom possible due to the lack of visibility regarding the timing of capital activity. Even if the fund’s performance has declined over the year, a performance fee might still be payable due to substantial redemptions occurring when the fund was above its high water mark.
Other considerations include the counterparty risk arising from repos, notional leverage from derivatives, allocation of P&L from the master fund to the feeder fund and the reasonableness of realised v. unrealised P&L. Caveating this, balance sheet, portfolio and ASC 820 disclosure only provide a snapshot of the fund at a single point in time, and this is generally at least three months out of date. Nevertheless, we consider a targeted analytical review of the AFS to be an important part of the operational due diligence review.
ODD Report Solution
Our ODD Report Solution is not just another tick in a box, it is an innovative approach to operational due diligence. A pragmatic solution for Investment Managers and Service Providers which engage us to complete an ODD review.
Investment Manager: Gemcorp Capital Management Limited – please contact here to request access to our September 2023 dated ODD Report
Investment Manager: Hivemind Capital Partners UK LLP – please contact here to request access to our September 2023 dated ODD Report
Investment Manager: 24 Capital Management Ltd – please contact here to request access to our December 2024 dated ODD Report
Investment Manager: MARK Capital Management LP – please contact here to request access to our December 2024 dated ODD Report
Investment Manager: Edge Capital Investment Management, LLC – please contact here to request access to our September 2024 dated ODD Report
Investment Manager: Redhedge Asset Management, LLP – please contact here to request access to our September 2024 dated ODD Report
Investment Manager: Fasanara Capital Limited – please contact here to request access to our July 2024 dated ODD Report
Investment Manager: Eltican Asset Management SAS – please contact here to request access to our July 2024 dated ODD Report
Digital Asset Service Provider: Copper Technologies (Switzerland) AG – please contact here to request access to our April 2024 dated ODD Report
Investment Manager: Hyperion Decimus, LLC – please contact here to request access to our March 2024 dated ODD Report
Investment Manager: Coral Cove Capital Ltd – please contact here to request access to our January 2024 dated ODD Report
Investment Manager: Wincent Capital Management Limited – please contact here to request access to our September 2023 dated ODD Report