Why does Operational Due Diligence matter? Operational failure is a significant cause of hedge fund liquidations. In a study of more than 100 hedge funds liquidations over 20 years, Feffer and Kundro (2003) found that “54% of failed funds had identifiable operational issues and half of all fund failures could be attributed to operational risk alone.” Of the funds in their study that were liquidated due to operational failures, 41% of liquidations involved misrepresentation of investments and performance, 30% involved misappropriation of funds and general fraud, 14% involved unauthorized trading and style breaches, 6% involved inadequate resources and 9% involved other operational failures.
Feffer, Stuart and Kundro, Christopher, “Understanding and Mitigating Operational Risk in Hedge Fund Investments” (March 2003).
Operational failure has also been the cause of substantial financial losses for large organisations over the last decade. The recent UBS loss of over $2 billion demonstrates that large or small, failure in controls surrounding people, processes and systems can have devastating consequences.