| |
| |
| Preface | |
| |
| |
| |
| What Is Operational Risk? | |
| |
| |
| Brief History | |
| |
| |
| Modern Definition of Operational Risk in a Hedge Fund Context | |
| |
| |
| Operational Due Diligence versus Operational Risk | |
| |
| |
| Key Areas | |
| |
| |
| External Risks | |
| |
| |
| Internal Risks | |
| |
| |
| Blended Risks | |
| |
| |
| The Five Core Themes | |
| |
| |
| |
| The Importance of Operational Due Diligence | |
| |
| |
| Why Should Investors Care about Operational Risk? | |
| |
| |
| Morton's Fork or a Hobson's Choice? | |
| |
| |
| Outright Fraud Still Exists | |
| |
| |
| Hedge Fund Fraud Cannot Be Modeled | |
| |
| |
| Small Discrepancies Add Up | |
| |
| |
| Lack of Standardized Regulation | |
| |
| |
| Each Hedge Fund Is Different | |
| |
| |
| Ability to Generate an Informational Edge | |
| |
| |
| Potential to Reduce Losses and Increase Returns | |
| |
| |
| Considering Operational Risk Factors Presents a Different View into a Firm | |
| |
| |
| Common Misconceptions | |
| |
| |
| Other Considerations: There Is Not Necessarily a Positive Correlation between Assets and Operational Quality | |
| |
| |
| A Study in Operational Failure: Bayou Hedge Fund Group | |
| |
| |
| Affiliated Broker-Dealer | |
| |
| |
| Large Discrepancies in the Performance of Onshore and Offshore Funds | |
| |
| |
| Declining Capital of Broker-Dealer | |
| |
| |
| Board of Directors: Members and Actions | |
| |
| |
| Lavish Expenses of Broker-Dealers | |
| |
| |
| Fake Audits Prepared by a Phony Auditor | |
| |
| |
| Background Questions | |
| |
| |
| Lack of Investor Communication | |
| |
| |
| Ties to People Barred from the Securities Industry | |
| |
| |
| Revision of Conflicted Marketing Materials | |
| |
| |
| Other Anomalies | |
| |
| |
| |
| Who Is Qualified to Perform an Operational Due Diligence Review? | |
| |
| |
| Essential Skills | |
| |
| |
| Primary Skills | |
| |
| |
| Primary, Secondary, Blended, and Other Skills | |
| |
| |
| In-house versus Outsourcing | |
| |
| |
| Evolution of Independent Operational Rating Agencies | |
| |
| |
| Benefits of Third-Party Rating Agencies | |
| |
| |
| Criticisms of Third-Party Rating Agencies and Operational Due Diligence Providers | |
| |
| |
| Factors to Consider before Performing an Operational Review of a Hedge Fund | |
| |
| |
| |
| Creating an Initial Operational Profile | |
| |
| |
| When Does an Operational Due Diligence Review Begin? | |
| |
| |
| Documentation | |
| |
| |
| The Pinata Problem | |
| |
| |
| Due Diligence Questionnaire: To Use or Not to Use? | |
| |
| |
| Background Investigations | |
| |
| |
| Other Considerations | |
| |
| |
| Importance of Onsite Visits | |
| |
| |
| Which Office to Visit | |
| |
| |
| Manager Interview Process | |
| |
| |
| What Topics Should Be Covered During an Onsite Review? | |
| |
| |
| Sample Topic Questions | |
| |
| |
| In What Order Should These Topics Be Covered? | |
| |
| |
| Service Provider Reviews | |
| |
| |
| Qualitative Operational Report: Documenting the Operational Data | |
| |
| |
| |
| Evaluating the Gray Areas: Examples | |
| |
| |
| |
| "It Was Not Me"-Hedge Fund Manager Claims Mistaken Identity | |
| |
| |
| |
| "It Was Me, But Everyone Was Doing It"-Are Regulatory Witch Hunts Real? | |
| |
| |
| |
| "It Was Me, But I Did Nothing Wrong"-Manager Proved Not Guilty | |
| |
| |
| |
| The Low-Profile Hedge Fund Manager-Is No News Good News? | |
| |
| |
| |
| The Infrastructure Outsourcer-Can One Administrator Do Everything? | |
| |
| |
| |
| The Mountain Climber-Can Plans for Large, Fast Growth Trip You Along the Way? | |
| |
| |
| |
| The Stumbling Giant-Can a Large Manager Lose Sight of Small Controls? | |
| |
| |
| |
| The Apologetic Headmaster-Are Junior Staff as Informed as Senior Management? | |
| |
| |
| |
| Ten Tips for Performing an Operational Due Diligence Review | |
| |
| |
| |
| Avoid Meeting with the Wrong People or the Wrong Groups | |
| |
| |
| |
| Get Out of the Conference Room | |
| |
| |
| |
| Little White Lies Can Turn into Big Problems | |
| |
| |
| |
| Be Wary of Phantomware | |
| |
| |
| |
| Focus on Documentation and Negotiation | |
| |
| |
| |
| Read the Fine Print (Financial Statement Notes, etc.) | |
| |
| |
| |
| Reference Checking: Importance of In-Sample and Out-of-Sample References | |
| |
| |
| |
| Credit Analysis: Are Funds Financially Viable? | |
| |
| |
| |
| Long-Term Planning: Key Staff Retention, Succession Planning, and More | |
| |
| |
| |
| Growth Planning: Is the Manager Proactive or Reactive? | |
| |
| |
| |
| Ongoing Operational Profile Monitoring | |
| |
| |
| How Often Should Onsite Operational Reviews Be Conducted? | |
| |
| |
| Remote Operational Due Diligence Monitoring | |
| |
| |
| Media Monitoring | |
| |
| |
| Litigation and Regulatory Monitoring | |
| |
| |
| Hedge Fund Communication Reviews | |
| |
| |
| Assets Under Management and Performance Monitoring | |
| |
| |
| Operational Events | |
| |
| |
| Effect of Discovery on the Magnitude of an Operational Event | |
| |
| |
| Onsite Visit Frequency and Operational Events | |
| |
| |
| Developmental Operational Traps | |
| |
| |
| |
| Techniques for Modeling Operational Risk | |
| |
| |
| Scoring Systems | |
| |
| |
| Building a Scoring System: Category Determination | |
| |
| |
| Category Definitions | |
| |
| |
| Combinations of Category Definition Approaches | |
| |
| |
| Category Weight Assignment | |
| |
| |
| Weighting Aggregation Model | |
| |
| |
| Weighting Disaggregation Model | |
| |
| |
| WAM versus WDM | |
| |
| |
| Category Weight Consistency and Reweighting Considerations | |
| |
| |
| Factor Marginalization | |
| |
| |
| Category Scale Determination and the Meaning of Scores | |
| |
| |
| Threshold Self-Assessment and Determination | |
| |
| |
| Score Assignment | |
| |
| |
| Discretionary Penalties and Bonuses | |
| |
| |
| Score Aggregation: Sum Totaling and Weighted Averages | |
| |
| |
| Criticisms of Scorecard Models | |
| |
| |
| Benefits of Scorecard Models | |
| |
| |
| Visualization Techniques | |
| |
| |
| |
| Bridging the Gap: Incorporating Operational Risk Consideration into the Portfolio Construction and Asset Allocation Process | |
| |
| |
| Proactive Monitoring: Graphical Universe Creation | |
| |
| |
| Proactive Management of Operational Risks | |
| |
| |
| Protecting against Conglomeration Risks: Multivariate Commonality Analysis | |
| |
| |
| Operational Directional Views | |
| |
| |
| Example of Multivariate Commonality Analysis | |
| |
| |
| First Objective: Total Diversity Goal | |
| |
| |
| Second Objective: FSA Overweight Goal | |
| |
| |
| Third Objective: FSA Underweight Goal | |
| |
| |
| Conclusions of Scenario Analysis | |
| |
| |
| Considering Operational Reviews in the Hedge Fund Portfolio Rebalancing Process | |
| |
| |
| Operational Drag | |
| |
| |
| Meta Risks | |
| |
| |
| Operational Factor | |
| |
| |
| Operational Scenario Analysis | |
| |
| |
| Can Operational Risk Be Entirely Eliminated? | |
| |
| |
| Factoring Operational Risk into Total Risk Calculations | |
| |
| |
| Beyond Scorecard Approaches: Discounting Expected Return | |
| |
| |
| Discounted Expected Returns with the Operational Factor | |
| |
| |
| Operational Haircuts | |
| |
| |
| Expected Return and Operational Risk | |
| |
| |
| Shape of the Expected Return versus Operational Risk Curve | |
| |
| |
| Second Operational Threshold | |
| |
| |
| Final Thoughts | |
| |
| |
| |
| Looking Ahead: Trends in the Space | |
| |
| |
| Increased Use of Consultants | |
| |
| |
| Commoditization of Background Investigations and Canned Operational Due Diligence Reports | |
| |
| |
| Increased Reliance on Service Provider Consulting Services | |
| |
| |
| Capture of Hedge Funds by Service Providers and Employees | |
| |
| |
| Hedge Fund Pursuit of Audit Certifications | |
| |
| |
| Operational Activism | |
| |
| |
| AU 332 and FAS 157 | |
| |
| |
| Development of Hedges to Operational Risks | |
| |
| |
| Links between Operational Risk and Credit Analysis | |
| |
| |
| Proposed Reregulation of the Hedge Fund Industry | |
| |
| |
| Index | |