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Opalesque Exclusive: Due diligence consulting firm calls for more checks on private equity funds, not just hedge funds

Friday, April 06, 2012
By Benedicte Gravrand, Opalesque Geneva:

Jason Scharfman runs an operational due diligence consulting firm called Corgentum Consulting , LLC, out of Jersey City, NJ. The firm performs reviews of funds, including hedge funds and private equity funds, for investors.

Ahead of his new book’s coming out later this month called Private Equity Operational Due Diligence (Wiley), his recent survey of approximately 150 Limited Partners was conducted in order to gauge trends in operational due diligence on private equity.

Regardless of any social or political criticisms, investors continue to invest in private equity (PE) funds, the survey says. As allocations to private equity funds continue to increase, so too does the level of scrutiny investors incorporate into this process.

87% of the survey respondents perform some kind of operational due diligence (DD) on fund managers. Of those, 62% do it internally, and most of their employees responsible for conducting DD also have other responsibilities. 24% of the investors who conduct DD use consultants, and many of the latter also provide investment advice.

Hedge funds are where the risk is, apparently. 84% of respondents think hedge funds have more operational risks, as compared to PE. Linking to that, 74% said they only perform operational DD on hedge funds and not on PE.

Of the 74% who conduct DD on hedge funds but not on PE funds, 57% said it was because it had not been done in the past, and so they were continuing the usual procedures. 12% were unsure of the benefits, 16% were unsure how to do it, and 11% don’t think PE funds pose so much risk.

Again, of the 74% who don’t perform DD on PE funds, 68% indicated they would do so in the coming year. Surveys do have that power. The reasons they gave range from the need to check all investments across a portfolio, increased pressure from individuals they managed money on behalf of, and more concerns about PE risks in general.

The most important PE risks are thought to be valuation first, then compliance and governance, followed by back office procedures, fraud, counterparty risk, and the role of the board of directors. The survey cites the Madoff Effect, not only applicable to hedge funds, which drives investors to tailor their approach towards DD based on recent fraudulent activity in the financial world.

“This study shows that private equity investors have not yet moved beyond Madoff, and are still lagging behind their hedge fund counterparts in the resources they are dedicated towards performing operational due diligence,” Jason Scharfman told Opalesque. “The good news is that the data shows that Limited Partners are turning the corner and starting to realize that poor private equity operations can be just as harmful as poor investment performance. With solid operational due diligence and developing dialogues about operations with General Partners, LP's can avoid unnecessary operational risks and generate better returns.”

Those who need some guidance on how to conduct operational DD on PE funds could contact such specialist consultants as Corgentum, of course.

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