In the wake of the financial crisis, the importance of due diligence is becoming more apparent by the day. For money managers in search of portable alpha products, hedge funds are attractive for the protection they offer, but risky due to the lack of transparency. However, it is possible to conduct due diligence when investing in hedge funds, according to industry experts.
Speaking at the Hedge Funds World conference at Toronto’s Dominion Club on Wednesday, Sonny Saksena, managing director at Holland’s Finles Capital Management said the process of doing due diligence is a long and careful one that begins with the first voicemail or email from a hedge fund manager. “For us, integrity and transparency is very important,” he said. “If we get a sense that something is not right, it will take us 12 to 14 months to flush it out.”
Finles’s three-pronged approach includes extensive quantitative analysis on hedge funds across the board, a research team to look for illiquid securities in the portfolio, and a business management team to evaluate the softer aspects. Each step is executed by at least two people, and an average manager search takes Finles seven months of due diligence and 12 weeks of board approval.
Neil Paragiri, managing director of Zurich’s Harcourt Alternative Investments, said his firm follows a well defined, bottom-up process. “You can call it an apples-to-apples approach,” he said. “Our analysts are specialists in their field, the idea being that they can compare the universe of managers they are affiliated with regardless of where they are based.”
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Having specialists as analysts allows them to look deeper into the manager’s performance and ask intelligent questions, according to Paragiri. Harcourt’s timeline for finding a hedge fund manager is anywhere from six months to a year, depending on their history and track record.
Leona Fields, pension fund manager for York University, said transparency is a big issue for her fund. She explained that an interest in hedge funds as an alpha generator was quickly turned down from York’s pension board when the issue of transparency was brought up. “I was asked why we would ever invest in something that we cannot understand,” she said. “We need transparency in order to invest.”
Paragiri explained that while his firm likes to get as much transparency as possible, it doesn’t mandate that every manager provide a full position report. Harcourt focuses more on exposure transparency, and usually just ask for a snapshot of the portfolio.
Saksena indicated that transparency in hedge funds was not a problem for his firm. Without elaborating, he explained that long-standing relationships can be a good substitute for hard numbers. “We’ve been investing in hedge funds for the last 15 years so we have ways of getting around transparency issues.”
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