Hedge Fund Due Diligence

Most Hedge Fund scandals would be avoided with proper due diligence performed by experienced managers.


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April 19, 2012: Death of a great investment counselor, Carl H. Otto

Updated: April 20, 2012

Improper Computer Systems (Software)


Humans make errors. Errors in the financial markets do occur – we hear about them all the time. Personally, I prefer to have ALL repetitive tasks fully automated and executed by well-designed and audited computer systems. And EXCEL spreadsheets, while being great research tools, are not proper tools for system development. In my due diligence, I have seen large investment firms managing TENS of BILLIONS of dollars using Excel spreadsheets with manual operations. This is a huge operational risk. Can you imagine the potential damage if there is a typo in the spreadsheet? Yes, this type of errors does happen.

Documentation & Code Quality

Investment managers, whether quantitative or not, depend on computer systems written by both analysts and programmers. Different programmers have different programming style. Those who know what “Spaghetti code” means know that computer programs, when improperly coded and/or maintained, can become less reliable and dangerous. Has the organization adopted a programming and documentation standard which details the naming conventions and programming principles? This may sounds ridiculous but it has great importance. If something happen and the code needs to be modified quickly, it is very important to have programs properly written with clear documentation.

While one will understand variable names like “interestRate” and “dividendDiscountModel”, the name of a super hero, a robot or some other cartoon character do not have their place in a professional program. Yet, I have seen those in my due diligence! Using foolish names makes an application dangerous and increases operational risk. One should not invest in investment organization with such bad business practices – even if past returns were good.

It is a question of time before the consequences of bad business practices show their negative impact. Firms should have:

  • Language standard (every programmer seems to have his/her own preference, yet a firm needs to standardize on a few computer language).
  • Coding style/standard.
  • Documentation standard.

For more information on computer systems, coding and documentation standards, please contact us.

Dominic Clermont, ASA, MBA, CFA

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