Operational due diligence review - is your fund prepared

Four steps to pass ODD with flying colors

Operational Due Diligence (ODD) isn’t new. It is a process that came about from numerous investment management firm failures beginning in 2002 with Beacon Hill Capital. Since then, there has been a steady increase in demand for improved governance, regulation and transparency, which requires high-quality infrastructure and processes to support that. The ODD process is more detailed and in-depth than ever, with ODD teams being given increased authorization over investment decisions.

Challenge for what is ODD?

Operational Due Diligence is the process by which investors gain an understanding of an investment fund’s operational infrastructure to assess whether its design and execution are resilient to operational failures and resulting financial loss. The process of reviewing an investment management firm can vary depending on the strategy and level of complexity; however, the overriding aim is to ensure that the manager is acting with integrity.

ODD is no longer just a buzzword. A CAIA Association study found that 39% of investors surveyed said they are unlikely to invest in a fund that hasn’t passed the due diligence process. Further, the choice of service providers, particularly the fund administrator, can either prevent or help push investor capital over the line. With ODD requests becoming the norm rather than the exception, how can fund managers best prepare? Outlined below are four ways investment managers can put their best foot forward to pass ODD with flying colors.

Prepare deliverables in advance

Although due diligence requirements and processes may vary slightly from investor to investor, there is still preparation fund managers can do to respond to investor requests efficiently. 

It is common for investors to begin with collecting all relevant fund documents so they can create a thorough report to use during onsite visits to verify the firm’s systems and controls. To respond quickly to this request, fund managers will benefit from gathering the following information in advance:

 

  • Fund marketing materials
  • Disaster Recovery Business Continuity manual
  • Organizational chart
  • Code of ethics
  • Monthly accruals summary 
  • Risk policy
  • Form ADV (if registered)
  • Due diligence questionnaire (DDQ)
  • Fund offering docs
  • Trade flow diagram
  • Valuation policy
  • Personal trading policy
  • Fund audits
  • Compliance manual
  • Executive biographies
  • Daily report samples
  • Cash controls policy

Fund managers should consider investing in a Virtual Data Room (VDR) to provide investors with access to due diligence documents in a secure, cloud-based portal. Data rooms are becoming more common as they provide a single location for multiple parties to access and request information, therefore streamlining the due diligence process. With the ability to set permissions and securely share documents, VDRs are becoming a mechanism to communicate between multiple parties, including the fund manager, the investor and service providers.

 

Lead with integrity

A culture of integrity must begin with senior management. Today, investors and managers alike realize the importance of disclosure and transparency. In order to retain investors and attract new capital, fund managers must be able to demonstrate efforts toward instilling a culture of integrity.

The culture should extend beyond the issues of fraud and focus on pursuing excellence, consistency and reducing the risk of errors. Training and clear communication go a long way in ensuring that all employees understand processes and procedures and follow them consistently.

A fund with conflicting information between documents, or between documents and statements made by employees, may signal a red flag. A buttoned-up operation with knowledgeable and open employees will go a long way in instilling investor confidence.

Engage trusted service providers

Institutional investors prioritize investing in a fund that has engaged top-tier service providers, especially firms they're familiar with. This includes legal counsel, auditors, fund administrators, prime brokers and compliance firms, among others. A well-known name will help ease investors’ minds. It is not unusual for funds to be vetoed for using an unknown or poorly regarded service provider. 

The role of the fund administrator is of such importance to the day-to-day operations of an investment firm that investors often complete separate due diligence on administrators to assess their systems, control environment, processes and staff. Due diligence on the administrator includes a review of the company history, background checks, regulatory checks as well as a review of their SSAE internal controls report (previously known as SAS70). Investment managers should consider conducting a similar audit of fund administrators before engaging one as they are a critical piece of investors’ ODD checklist. Given that the top 10 administrators make up 73% of clients’ funds administered with the top three totaling 40%, engaging a well-recognized name or a firm that is already on the investors’ approved list can help fund managers achieve a checkmark.

Be prepared to go virtual

The COVID-19 pandemic has changed the way many organizations conduct business, including investors. A recent study from the Investment Management Due Diligence Association found that 29% of investment due diligence officers no longer carry out reviews in person. Digitalizing documents and creating a shared agenda may help the review proceed smoothly for all parties. Virtual Data Rooms have become increasingly popular as they securely store documents and allow multiple users to access the documents simultaneously. In addition, internal parties should plan to take the meeting via video to improve communication quality.

Under traditional ODD methods, coordinating meetings and travel is standard practice. A remote process can be more cost-effective and gives investors more opportunities to conduct a detailed and comprehensive review. Whereas an in-person review may be just a one-day onsite meeting, remote ODD allows for multiple sessions and interviews over the course of several days.

With more investors carrying out ODD before they cut a check, fund managers should invest the time and resources into providing a solid response to investor requests. This begins with preparation and ensuring that all firm employees are aligned on what is required to ensure the firm passes ODD requests with flying colors.

How can Sanne help?

As service providers, we see ourselves as a transparent extension of the CFO that hired us. Sanne is one of the world’s leading providers of alternative asset and corporate administration services. Specialist expertise is delivered across private equity, private debt, capital markets, real assets, hedge and corporate services. We leverage our broad global network to provide clients and their investors with a comprehensive servicing solution. As such, Sanne is a recognized and highly regarded fund solutions provider to global asset managers. Get in touch with a member of our team to learn how our experts can help fund managers prepare for ODD requests and more.