Great Investor Expectations: What’s New in Operational Due Diligence?

Our directors Deanna Derrick and Robert Meschi sat alongside other hedge funds experts this week at HFM’s breakfast briefing panel that we hosted in NYC. The final discussion of the year within the thought leadership series addressed key trends in operational due diligence (ODD) including investor expectations, shifting priorities and recent developments in due diligence questionnaires (DDQ). Read below for key themes of the discussion.

Some things never change, but ODD is expanding

Just 15 years ago ODD was reserved to the largest firms, but more recently smaller allocators and family offices investing in hedge funds and private equity have adopted the practice. While investors were previously at an arm’s length from ODD, they’re now integral and becoming increasingly savvy and specific in their questionnaires.

Questions asked five or ten years ago haven’t disappeared, but DDQ has expanded. With priorities shifting, we see more hot button issues added. The fundamental inquiries still remain: Who’s trading? What’s the strategy? What’s the risk? And questions on controls of movement of cash are still a focus. However, these days there are more inbound inquiries on environmental, social and corporate governance, the make-up and diversity of the fund’s investment manager and service providers, and the inevitable questions regarding rapidly evolving technology.

Cyber and diversity matters

On hot button issues, cyber developments and attention to diversity is at the forefront.

Not only does ODD cover standard security aspects of tech, like two-factor authentication and spear-phishing tests, investors are considering how evolving technology helps control costs. Fund expense ratios are another aspect of ODD that isn’t going away, but how to align fast moving technology and cost saving measures is a budding inquiry for ODD. Additionally, for the first time outside of large public firms, we’re seeing a focus on both women and minority owned funds and service providers. We see an emphasis on socially responsible investing trending, and competition for the best ideas is key—more diverse teams lead to a wider breadth of ideas positively impacting performance.

Know your service provider

ODD is starting earlier and going deeper. More informed questions are being asked about service providers, extending beyond the who, what, and where. Now it’s crucial to hone in on vendor relationships as DDQ often requires the service providers themselves to participate in the inquiries. A good service provider is well versed, knows their area of expertise and exhibits ownership during ODD. Providing comprehensive and knowledgeable answers during DDQ is advantageous and builds investor confidence. For this reason 90% of the panel audience would consider a mock audit to prepare for ODD, while 10% of the attendees already have this practice in place.

For more information on key takeaways from the panel or to make sure you’re prepared for ODD, reach out to our Funds experts.