I have spent a great deal of time talking to Fund of Funds, Investment Consultants, and Investors about their methodology for reviewing funds. Most players have a rigorous methodology for review of quantitative return streams…..and then comes the review of the DDQ (Due Diligence Questionairre).
This is a story I see played over and over again. Analysis, analysis, analysis, and then the DDQ. For some reason the analysis stops at the DDQ and the DDQ is accepted as-is (or with a few minor follow-up questions). The worst part of the story is that one message is extremely clear. IF FUNDS OPERATE LIKE THEY PROMISED, MOST WOULD NOT HAVE FAILED. This is true regardless of the firm’s ability to generate a high-yielding return stream.
Think of the irony here. You have a DDQ on paper that spells out an operating model and operating principles, but rather than explore these with the same rigor of a return stream, you simply accept the DDQ as is. Remember Neville Chamberlain and the “Peace For Our Time” DDQ that Hitler signed prior to WWII. Just because it is on paper does not mean the practices stated are the true operating model. This leads me to my second conclusion – Review of a DDQ is not Operational Due Diligence.
The same rigor, investigative analysis, and modeling can be applied to an operational analysis. This rigor involves analyzing the intersection of people, process, systems, and data in three dimensions – investment management, risk management, and operations management. “Trust, but Verify” is the mantra that should be followed regarding fund operations.
For more information on Operational Due Diligence, please see my website at www.p-t-t.com.