As the alternative investment industry continues to grow and mature, so too does the prominence of operational due diligence (“ODD”) as part of investors’ overall due diligence efforts. ODD has become a mandatory component of the overall due diligence process for many investors, including for those investors who customarily allocated to more traditional long only strategies via separately management accounts (“SMAs”). ODD is especially important for those investors that operate within stringent fiduciary standards. The reputational impact of investing in a fund that suffers losses due to operational failures may exceed the impact of losses due to underperformance. Weak internal controls and infrastructure can lead to operational inefficiencies that in turn could negatively affect an advisor’s investment strategy.
Many investors are now very familiar that the fraud perpetrated by Bernie Madoff and the failure of both Lehman Brothers and MF Global prompted an increased focus on ODD. In addition to outright fraud and counterparty failure, a number of other concerns including cybersecurity and data breaches at major institutions, changes within the regulatory landscape both in the US and abroad, and operational risk lapses at some of the largest global banking institutions have contributed to the importance of ongoing operational due diligence.