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Alternative Investment Features, Methods, and Structures: practice question
An allocator performing due diligence on the Nethermoor Fund, a privately offered hedge fund, splits its work into investment due diligence and operational due diligence. Which of the following reviews is best classified as operational due diligence?
- Confirming that an independent administrator reconciles the fund's cash and positions with custodian records
- Stress-testing the portfolio to judge how the fund's leveraged positions would behave in a rate shock
- Assessing whether the manager's record reflects skill or luck by comparing the fund's alpha with that of peers
Show answer and explanation
Correct answer: A
Explanation: Confirming that an independent administrator reconciles the fund's cash and positions with custodian records tests the fund's operating infrastructure and controls — the risk that reported values or cash are wrong or misappropriated — which is the essence of operational due diligence. Stress-testing leveraged positions in an interest-rate shock evaluates the market risk of the strategy itself, which belongs to investment due diligence. Comparing the fund's alpha with that of peers to judge skill versus luck is an analysis of the strategy's return sources and persistence, again investment due diligence.
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