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Hedge Fund Operational Due Diligence Corgentum Insights Private Equity

Hedge Fund Operational Due Diligence Corgentum Insights Private Equity

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Originally posted in the August 2012 edition of Corgentum Consulting's Operational Due Diligence Insights.
Originally posted in the August 2012 edition of Corgentum Consulting's Operational Due Diligence Insights.

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Published by: Corgentum Consulting on Aug 23, 2012
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05/13/2014

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PE LP's Are Utilizing Operational Due Diligence toMake Their Voices Heard
Increasingly, private equity investors, commonly referred to as Limited Partners or LP's, are performingoperational due diligence prior to allocating to private equity funds. It is good to see that LP's have takencues from their hedge fund counterparts, and are increasingly recognizing that private equity fundspresent just as many, if not more, operational risks to investors as compared to hedge funds.Unfortunately, private equity fund managers, commonly referred to as General Partners or GP's, havebeen slower than their hedge fund portfolio manager counterparts in listening to LP feedback. This is tobe expected as GP's have long capitalized on the long-term nature of private equity investing to insulatethemselves from frequent interaction with LPs.In the past, after an LP committed capital, there were little if any updates from GPs outside of prescheduled updates, generally quarterly, on portfolio performance. Such an arrangement haseffectively robbed LPs of their voice as partners in the investing process. More LPs have come toacknowledge this fact, and are increasingly pro-actively sharing feedback with GPs after the initial andongoing operational due diligence processes.So consider for example, an LP who is considering making an investment in a private equity fund. This LPhas wisely decided to perform operational due diligence on the GP. After the review, the LP has a list of several operational deficiencies and areas in which the LP feels compared to their peers the GP couldimprove.Continuing our example, let us assume that from the LPs perspective none of these items are so seriousas to preclude him from investing, but rather he would feel more comfortable if the GP took correctiveaction on these matters. At a minimum, the LP feels it is important to make the GP aware of theseissues.While previously a GP may have politely listened to such feedback and taken little corrective action,more LPs are increasingly monitoring how well GPs respond to this feedback. This includes performingongoing operational due diligence to both monitor process improvements, as well as to detect any newoperational risks.Clinging to their old ways, however, many GPs aren't frankly interested in this ongoing LP operationaldue diligence process or receiving any such feedback from LPs that have already committed capital. Tofacilitate this lack of dialogue, GPs utilize a structure whereby they have so-called advisory boards uponwhich typically sit the largest investors in a particular fund. As such, smaller LPs effectively becomesqueezed out of the process. More LPs are beginning to realize the flaws in such arrangements and havedecided to become proactive not only in their due diligence efforts, but in engaging with GPs in morefrequent dialogues concerning both investment and operational issues.

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