In conversation: Gwen Stone, Operational Due Diligence, Director at K2 Advisors

Ahead of the Hedgeweek US Leadership Summit in New York on 12 September, Gwen Stone, Operational Due Diligence, Director at K2 Advisors (Franklin Templeton), talks to us about seeing manager relationships as partnerships, the importance of an internal resource and why new managers should focus on scalability.

Hedgeweek (HW): What are the most common challenges you encounter in operational due diligence?

Gwen Stone (GS): There are actually quite a few challenges in the operational due diligence world on a day-to-day basis; we can sometimes find ourselves in an internal balancing act. It’s quite delicate in the sense that the front office may like a manager based on performance and/or suitability, but ODD needs to ensure that the manager maintains an institutional operational framework. Balancing the two can be a challenge.

Other challenges include having confidence in managers’ transparency and candor – without it, we will walk away. We treat our relationships with managers as partnerships, so honesty and transparency are fundamental. Great things can happen if  everyone’s in sync and interests are, to a certain extent, aligned.

Lastly, I would say one of the more fun challenges is staying abreast with the latest regulatory news, industry trends, new vendors, and all of the associated risks. We address this by attending conferences, networking and meeting with all the vendors out there to see what their current offerings are, but also poking and prodding them. If I identify a manager’s need that could be addressed by a vendor, I facilitate introductions without pushing recommendations, allowing them to explore potential solutions on their own.

HW: How have investor expectations evolved in recent years, and what do new hedge funds need to do to meet these expectations?

GS: Over the last few years, transparency has become increasingly more paramount, and the baseline now calls for even more institutional processes to be in place. For example, the automation of processes and controls in trade flow — paper blotters are no longer a thing, right? That’s just becoming the norm. Trade flow, compliance, IT: all of these are much more institutional.

New hedge funds need to balance between the time, cost and efficiency of running their operations, while also managing and overseeing their relationships with outsourced vendor and consultant relationships. While outsourcing has become much more prevalent, most new managers — smaller managers especially — need to ensure they have an internal resource capable of managing that relationship. That internal resource must be knowledgeable and conversational in the functions provided by the vendor. That is something I’m able to glean pretty quickly during my conversation with the manager, and seeing whether this internal resource knows what their outsourced vendor is doing and is able to be fluent in that.

HW: How have recent regulatory changes impacted operational due diligence practices, and what should hedge funds be prepared for in the future? 

GS: Regulatory scrutiny has increased to such an extent and has impacted almost every aspect of the managers’ day-to-day operations, most notably in technology and compliance. Think about the impact of the new marketing rule and regulatory scrutiny around electronic communications, and those are just two in the slew of regulatory changes that have occurred.

Managers should be able to show ODD professionals how they’ve responded to regulatory changes and the headlines — not necessarily those that have already been passed, but also those that may come in future. This includes how they’ve updated their policies and procedures, how they’ve trained employees, how they’ve tested employees and tested their own policies and procedures internally.

In my opinion, the better managers are the ones who don’t necessarily wait to respond to regulatory changes but are proactive in their approach and consistently strive to achieve industry best practices ahead of the curve. While some managers might take a wait-and-see approach; the more forward-thinking managers have already conducted scenario analyses, taken stock of their current capabilities and performed audits to prepare should those rules come into effect.

HW: What advice would you give to new hedge fund managers seeking to build effective ODD practices?

GS: New managers should build something that’s scalable, something they can grow into, something that’s institutional, especially if that’s the type of capital they’re looking to attract, despite their current size and strategy. Build for what you strive to achieve.

That said, we have to remember that different investors have different types of risk tolerances, so build something that’s best suited for the type of capital they’re looking to attract. As I said earlier, treat your potential investors as partners and work with them to seek their guidance on what their risk tolerance might be.

I also wanted to note that outsourcing, which we talked about earlier, is definitely much more acceptable today than it was a few years ago, so new managers can certainly outsource or use a co-source model where appropriate. However, as I said before, there must be an internal resource managing that relationship. Again, that internal resource must be knowledgeable and well-versed in what that vendor is doing.

I would also add that new managers should talk with industry resources and colleagues following best practices, attend industry events and ask a million questions. I go to events where people ask me questions, and I’m always happy to discuss what we believe to be best practices. The more you learn from others in the industry, the better positioned you’ll be to build effective ODD practices.

HW: Will you be drawing on some of the above themes during your panel at the summit? What are you hoping to gain from the day?

GS: One hundred percent. I think that these are the foundations of ODD: partnership, transparency, being proactive, following and looking to adhere to institutional best practices. So, without a doubt, I think that we’re going to touch on these themes and I’m really looking forward to knowledge-sharing, exchanging best practices and meeting like-minded people.

Gwen Stone, Director, Operational Due Diligence, K2 Advisors – Gwen Stone joined K2 Advisors in April 2015 as an analyst on the operational due diligence team. Prior to joining K2, Gwen was with Fitch Ratings for seven years, where she worked in the fund and asset manager rating group as Lead Analyst for various ratings and operational assessments assigned to asset managers, money market funds, collateralized loan obligations, closed-end funds and local government investment pools. Gwen also spent two years as an analyst at the CDO group at Standard & Poor’s. She began her career at PricewaterhouseCoopers’s capital markets group, conducting tax work for hedge funds and investment partnerships. Gwen holds a J.D. from Brooklyn Law School and a BS in Business Administration from Babson College.

Want to learn more? Join us at the Hedgeweek US Leadership Summit on Thursday, September 12 at Convene 101 Park Avenue, New York. Register for your complimentary pass here.  

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