In-depth guide · Governance
Operational due diligence: reviewing asset managers and funds
Updated: · Leutrim Miftaraj, FLIORE · Editorial standards · Other languages: Deutsch · Français · Español
Short answer
Operational due diligence does not test whether an investment strategy is good, but whether the business behind it is safe: who holds the assets in custody, who values them, who controls, how fees are calculated, how secure IT and data are, how independent administration and audit are. Many large losses arose not from poor investments but from operational failings. The review belongs before every commitment and in ongoing monitoring.
Investment due diligence and operational due diligence
Investment due diligence asks whether a strategy promises returns and whether the team can implement it. Operational due diligence asks whether the firm behind it is organised so that the assets are safe and the reported figures are correct. Both are needed, and they should be assessed by different people: someone convinced by a strategy easily overlooks operational warning signs.
Areas of review
| Area | Core questions | Evidence |
|---|---|---|
| Organisation and owners | Who owns the manager, who decides, how stable is the team? | Register extract, organisation chart, CVs |
| Regulation | Is the manager licensed and supervised, have there been proceedings? | Entry in the supervisor's registers, audit reports |
| Custody | Are the assets held by an independent custodian bank? | Custody agreement, confirmation from the custodian |
| Valuation | Who values, by which method, how independently? | Valuation policy, administrator's report |
| Administration and audit | Is there an independent fund administrator and a recognised audit firm? | Contracts, audited financial statements |
| Fees | How are management and performance fees calculated, are there third-party payments? | Fund documents, fee calculation |
| IT and cybersecurity | How are data, access and payments protected, is there an emergency plan? | Security policies, certifications, test reports |
| Compliance | How are conflicts of interest, personal trading and money laundering handled? | Directives, compliance report |
Red flags
- Custody or valuation by the manager itself or by related companies.
- An unknown or very small audit firm for large assets.
- Conspicuously smooth returns that do not fit the strategy.
- Reluctance to provide information, or refusal of visits and conversations with service providers.
- Frequent changes of auditor, administrator or key people.
- Complex structures without an apparent reason, for example in lightly regulated countries.
Process
- Send a questionnaire, for example based on the AIMA or ILPA templates.
- Review answers and evidence, noting contradictions.
- Meet or visit the manager, with questions to operations, compliance and IT – not only to the investment team.
- Obtain independent confirmations, for example from the custodian and the administrator.
- Document the result with an assessment per area and conditions; with serious deficiencies, no commitment.
- Monitor on an ongoing basis: annual update, events such as staff changes or proceedings.
Worked example (simplified)
A family office reviews a small fund with a convincing strategy. The answers show that the fund administrator is a sister company of the manager, the audit firm is barely known, and the custodian confirms only part of the holdings. The investment team is convinced; the operational review recommends rejection. The investment committee follows the recommendation and offers to review again once an independent administrator and a recognised audit firm have been appointed.
Documentation and repetition
The results belong in the investment's file together with the investment memo. An update at least once a year makes sense, and additionally after events such as the departure of a key person, a change of audit firm or reports of supervisory proceedings. Licences can be checked on an ongoing basis in the public registers of the supervisory authorities, such as FINMA, BaFin or the FMA.
Reviewing fees and third-party payments
Fees are an often underestimated part of the operational review. Besides management and performance fees, there are costs for administration, audit, legal, transactions and financing, which depending on the fund documents are charged to the fund. For performance fees, it must be checked whether a high-water mark applies, whether a hurdle rate is provided for and how losses are treated.
For private market funds, transaction and advisory fees at the level of the portfolio companies are added; according to the ILPA recommendations, they should be disclosed and offset against the management fee. Finally, third-party payments belong in the review: if the manager or an intermediary receives payments from third parties, conflicts of interest arise that must be disclosed and governed. A complete fee overview in per cent and in absolute amounts per year belongs in every review file.
In FLIORE
FLIORE stores questionnaires, answers, evidence and the result of the review with versions on the investment, keeps update dates in the compliance calendar and links the review with the commitments, valuations and reports of the investment.
At a glance
| Aim | Safety of the business behind an investment |
|---|---|
| Core areas | Custody, valuation, administration, fees, IT, compliance |
| Templates | AIMA and ILPA questionnaires |
Frequently asked questions
Is an operational review needed for large, well-known managers too?
Yes, although often to a lesser extent. Size does not protect against operational failings; the review can focus on changes and key areas.
Who should carry out the operational review?
Ideally not the same person who recommends the investment. In small family offices, an external specialist can make sense.
What is the most important feature to check?
The independence of custody, valuation and audit. If all three lie with the manager or related companies, particular caution is called for.
How often is the review repeated?
At least annually, and after events such as staff changes, changes of auditor or supervisory proceedings.
Does this also apply to direct participations?
In adapted form: governance, financial reporting, audit and information rights belong in the review of direct participations too.
What is a high-water mark?
A rule under which a performance fee is only charged again once a previous peak in the unit value has been exceeded. The investor thus does not pay twice for the same increase in value.
How is a manager's IT security reviewed?
With questions on access, two-factor sign-in, payment approvals, backups and the emergency plan, and with evidence such as ISO/IEC 27001 certifications or reports from independent auditors.
What if a manager does not answer questions?
That is itself a result of the review. A lack of transparency on custody, valuation or fees should generally lead to rejection.
Sources
- AIMA – due diligence questionnaires
- ILPA – Due Diligence Questionnaire
- CFA Institute – standards
- FINMA – authorised institutions and supervision
- BaFin – company database and supervision
- FMA Austria – company database
This page provides orientation and does not replace legal or tax advice. The cited legal sources in their applicable version are authoritative.
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