Critical Differentiators in Operational Due Diligence for Investment Managers
Competition for investments is fierce across the alternatives industry, so what makes a fund stand out and what role does operational due diligence play in winning institutional assets? During a recent webinar, we invited Boris Onefater, Founder and Managing Partner at Constellation Advisers, to examine how alternative investment firms can leverage the ODD process to stand out from their peers. Below are a few key questions and answers from the conversation (paraphrased, of course). You can also watch the full webinar at the bottom of this article or by clicking here.
How has due diligence evolved over the years?
Due diligence has evolved significantly over the last 20-25 years. Prior to 1992, most of the focus was on investment due diligence. Starting around 2005, due diligence began to evolve on a fundamental level and verification and validation of service providers became a normal and accepted practice. Post-2008, the ODD pendulum really started to swing, particularly as firms began to rely more heavily on third parties.
Where have expectations around due diligence migrated to and what areas of operations are investors most concerned about?
Investors are asking harder questions; they really want to know answers. Investment firms are expected to be much more transparent than ever before, and that transparency is only being expanded. Investors are most concerned about whether assets exist fundamentally and what controls are in place over those assets and any movement of cash. Cybersecurity and strategies for preventing cyber-attacks are also top-level concerns.
What types of technology-related questions are being asked and what expectations do investors have for technology during the ODD process?
We’re seeing a lot of funds are moving their technology to the cloud and they’re engaging quality service providers to mind that data for them. Whether a fund is leveraging one of these service providers or still managing IT in house, what investors and ODD teams need to understand is if they have good control over the technology and what they are doing internally and externally to protect both the physical and electronic security of the firm’s data. At the end of the day, the investor wants to come away with how the firm’s IT practices translate into potential risk.
What are common issues that can stall the ODD process or some red flags that should concern investors?
Probably the biggest red flag is a lack of control over cash, if anyone or if a number of people in the firm can trade without any controls. Investors need to understand if money can move without adequate oversight. External risks are also a big concern, and that includes someone getting in through a cyber-attack or if someone does something from the outside that would affect the business operationally.
How are firms preparing in advance for ODD meetings today? Are mock due diligence assessments growing in popularity?
Mock due diligence assessments are growing in popularity, and firms are doing a lot more of them. In addition to that, it’s important to look at your due diligence materials and making sure they are up-to-date.