Can you ask an administrator what is in a portfolio?
Each year, Castle Hall completes operational due diligence on several hundred hedge funds. As part of that process, we speak with each administrator to both understand and evaluate the quality of that admin's procedures, and also to corroborate information provided to us by each manager. This latter part of the process is very important: it is evidently vital that the third party service provider confirm key information to validate and cross reference data provided by the manager.
One of the questions we always ask is for the administrator to confirm the percentage of each hedge fund's portfolio held in each main category of financial instrument. We do not ask for portfolio transparency, but do need the admin to confirm, with reasonable accuracy, the percentage of each book in equities, bonds, derivatives etc. Clearly, if a manager indicates that 5% of the portfolio is in hard to value securities, but the administrator indicates that the percentage is actually 29%, we have a discrepancy that needs to be resolved.
We hope this is not a sign of things to come, but we recently encountered one of the "leading" administrators who stated that their new policy was to only tell investors the types of instrument in the portfolio. That's all fine and dandy, but it doesn't really help much if the admin tells us that the portfolio contains distressed debt - we need to know whether we're talking about 5% or 50%.
To our amazement, the admin stated that they would charge what, in their words, was a "significant" fee to provide any analysis by percentage - even though (we hope!!) the administrator has a portfolio report which should list the percentages as a matter of course. In other words, the administrator's new policy is to charge for reading out information available on their computer screen (or, at worst, available after 3 minutes with a calculator). Moreover, the admin would charge this fee as an out of pocket expense to the fund, so the due diligence request of one investor ends up being paid by all.
As above, we hope that this is not a sign of things to come. However, each of these individual conversations continues, most unfortunately, to undermine investors' confidence in the administration industry, and particularly undermine the view that administrators have a commitment to fulfill a watchdog role to protect the investor. An unwelcome precedent, to say the least.
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Hedge Fund Operational Due Diligence
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