Operational due diligence considerations

Frank Napolitani, Constellation

By Frank Napolitani (pictured), Constellation Advisors – Given today’s challenging capital raising environment, it is more important than ever to ensure that key, non-investment functions of an investment management firm are being addressed and managed properly. Operational Due Diligence (ODD) plays an integral role in the allocation of institutional capital. 


According to the 2019 JP Morgan Institutional Investor Survey which collected responses from 227 allocators with a combined USD706 billion in capital invested across hedge funds globally, 33 per cent of investors stated they had chosen not to allocate to a specific manager because that manager did not pass ODD. Once an investment manager has been vetoed, the odds of being reconsidered by that institutional investor are extremely low. 

For an institutional allocator, ODD is the back-end of the investment process meant to hedge operational risk. The focus of ODD is to gain an understanding of an investment manager’s operational infrastructure and to protect investors from potential losses resulting from operational failures in the firm. Generally, it is not just one item that will cause a manager to fail ODD, but rather a handful of violations that when looked at in aggregate, are too risky for an ODD practitioner to disregard.

Reasons why a manager may be vetoed

There are a number of reasons why an investment manager may be vetoed by an ODD practitioner. These may include, but not be limited to: 

  • Self-administered funds;
  • Poor segregation around cash controls (e.g. at least two signatories for cash movements);
  • Unwillingness to provide transparency or uncooperativeness during the ODD process; 
  • Insufficient operational and technological infrastructure to support the fund’s investment strategy;
  • Weak or unclear valuation policies combined with deviations of estimates of NAV, restated NAV and/or audited financial statements; 
  • Unsatisfactory service provider engagement during the ODD process;
  • Regulatory and compliance issues; 
  • Lack of integrity. 

Deliverables required for an ODD exam

An investment management firm can assume that a number of items will be requested for the on-site portion of an ODD exam. These items may include, but not be limited to:

  • Fund marketing materials;
  • DRBC manual;
  • Organisational 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. 

Preparing for an on-site ODD exam

An institutional allocator will generally spend between four and six hours preparing for the on-site exam. ODD practitioners take a practical approach to these on-site exams, and providing the requested deliverables outlined above ahead of time will help their pre-exam preparation. The on-site exam will often vary by size and complexity of the investment management firm’s investment strategy. 

As the investment management industry continues to evolve, managers who choose to adopt a Best Practices operational infrastructure will fare far better in the capital raising process than those who do not. Institutional allocators have accepted taking on investment risk, however, they will not accept operational risk, and successfully passing ODD is the key hurdle in this process. 


Frank Napolitani
Managing Director & Global Head of Buisiness Development & Marketing, Constellation Advisers LLC

Prior to joining Constellation in 2019, Frank Napolitani was a Director and National Head of Business Development for the financial services practice at EisnerAmper LLP for several years. Prior to EisnerAmper, he served as Managing Director, Prime Brokerage Sales at Concept Capital Markets, LLC, the predecessor company to Cowen Prime Services, from 2008 to 2015. 

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