Research Note / Operational Due Diligence
A working operational due diligence checklist for hedge funds: what to request, what to verify, how the questionnaire and report differ and which findings should pause a deal.
- Focus
- Operational due diligence checklist
- Audience
- Allocators and managers
An operational due diligence checklist for a hedge fund is an ordered list of what an allocator requests and verifies about how a manager runs money: governance, entity, service providers, the trade lifecycle, valuation, cash, compliance, technology and legal terms. It is separate from the investment review. It asks whether the firm can handle capital correctly every day.
This note gives a working checklist, explains the difference between an operational questionnaire and an operational due diligence report, lists the findings that should pause a deal and says when outsourcing the review makes sense. It is educational, states no performance figures and is not an offer or solicitation.
What does operational due diligence mean?
Operational due diligence, or ODD, is the review of non-investment risk at a manager: whether the people, processes, controls and providers around the strategy are sound. Investment due diligence asks whether the strategy has an edge. ODD asks whether a failure in operations could cost the investor money regardless of the edge.
For the version aimed at emerging managers, see operational due diligence for emerging hedge fund managers. This note is the allocator's checklist.
What belongs on an operational due diligence checklist?
The table lists nine areas, what to request and what to verify independently. Requests describe the manager's claims. The verification column is the part that cannot be left to the manager.
| Area | Request | Verify independently |
|---|---|---|
| Governance and people | Organization chart, biographies, who approves what, succession plan | Reference calls with former colleagues and counterparties; role descriptions against the organization chart |
| Entity and regulation | Constitutional documents, ownership chart, regulatory status | The regulator's public register and the legal entity identifier record |
| Service providers | Names of administrator, auditor, prime broker or custodian, legal counsel | A direct call or confirmation from each provider, not routed through the manager |
| Trade lifecycle | Written process from order to settlement, who confirms and who reconciles | A sample of recent trades traced from order to broker confirmation to the books |
| Valuation and pricing | Pricing policy, sources, who can override a price | Prices compared with an independent source for a sample of positions |
| Cash and custody | Where assets are held, who can move cash, signing authority | Custodian or broker confirmation of balances and of who has authority |
| Compliance and conflicts | Compliance policies, personal trading rules, conflict register, outside activities | Evidence the policies are used, such as logs, approvals and sign-offs |
| Technology and continuity | Systems list, access control, backup, business continuity and cyber policy | A recent test record, and what happened the last time something failed |
| Legal terms | Governing documents, fee and liquidity terms, termination terms | That marketing material matches the governing document |
A good checklist is applied the same way to every manager, so differences in answers, and in the evidence behind them, become visible.
What is the difference between an operational questionnaire and an ODD report?
An operational questionnaire is the manager's side: written answers to a set of questions, often a section of a larger due diligence questionnaire. An ODD report is the allocator's side: a written record of what was reviewed, what was verified, what was found and what follow-up is open.
A useful report usually states the scope and date of the review, the documents and calls it relied on, findings graded by seriousness, the manager's response to each finding and any conditions attached to a decision. Formats differ between allocators, so treat this as a common shape rather than a standard.
Which findings should pause a deal?
None of these proves wrongdoing. Each is a reason to stop and ask until the answer is documented.
- One person can place, confirm and record a trade with no second check.
- The administrator, auditor or prime broker cannot be contacted, or the manager asks you not to contact them.
- Valuations come only from the manager, with no independent price source.
- Cash can be moved by the manager without a second signature or provider approval.
- Governing documents differ from marketing material on fees or liquidity.
- Policies exist on paper, but nobody can show the last time one caught something.
- The answers change between the questionnaire, the meeting and the documents.
Findings are weighed together. A small team with one control gap and a dated plan to close it is easier to accept than a large team that claims no gaps.
How do reference calls and site visits fit in?
Documents show what the manager says. Calls and visits show whether it matches. Speak to the administrator and the prime broker or custodian about how the manager behaves day to day. Ask former colleagues about the principal's role. If an in-person visit is not possible, ask for a walk-through of the trade and reconciliation process on a video call using a recent real example, not a slide.
When does outsourcing operational due diligence make sense?
Some allocators run ODD with their own team. Others use an independent specialist. Outsourcing can add capacity and a second opinion, and it can make a smaller allocator's review more consistent. The trade-offs are cost, the time to brief an outside reviewer and the fact that the allocator still owns the decision. Whoever does the work, ask for the scope, the evidence relied on and the list of open items in writing.
How does a managed account change the checklist?
In a separately managed account the assets sit in an account in the allocator's name at the allocator's own broker, and the manager holds trading authority only. Custody and cash move outside the manager's reach, so those rows of the checklist get lighter. Order routing across many accounts, reconciliation and how each mandate is applied get heavier. The note on trade-only managed accounts covers the mechanics.
Qlumina's operational review is the second of three gates for a program on the Apex Marketplace, after the quantitative review and before the live pilot. The full method is on the quant fund diligence page. You can browse programs or the Apex Marketplace; program statistics unlock after investor verification. More reading is in all research notes.
Frequently asked questions
What is an operational due diligence checklist for a hedge fund?
It is an ordered list of what an allocator requests and verifies about how a manager operates: governance, entity, service providers, trade processing, valuation, cash, compliance, technology and legal terms. It is applied to every manager the same way so differences become visible.
What is the difference between an ODD questionnaire and an ODD report?
The questionnaire holds the manager's written answers. The report is the allocator's record of what was reviewed, what was independently verified, what was found and what remains open.
What are red flags in operational due diligence?
Common ones are one person controlling a trade from order to record, providers who cannot be contacted, valuations with no independent source, cash that can be moved without a second approval, and answers that change between documents and meetings.
How long does operational due diligence take?
There is no fixed time. It depends on the size of the manager, how quickly evidence arrives, how many providers must be contacted and how many findings need follow-up. Allocators should plan for it to take longer than the manager expects.
Does a separately managed account remove the need for operational due diligence?
No. It removes the risk of the manager holding the assets, because the account is in the investor's name at the investor's own broker. Execution, order routing, reconciliation and the application of each mandate still need review.
Risk and eligibility
Investing involves substantial risk of loss. The value of investments and the income derived from them can fall as well as rise, and investors may not recover the amount originally invested. Past performance is no guarantee of future returns. This note is for professional investors only, is educational, and is not an offer or solicitation of any kind. Qlumina is a BVI FSC approved investment manager. See the risk disclosure.
Allocators and managers
Managers can read how the three gates work and what is examined, and apply through the contact form on the portfolio managers page.
Research notes are published for professional readers. Not an offer or solicitation. Risk disclosure
