Hedge Fund Analysis: An In–Depth Guide to Evaluating Return Potential and Assessing Risks

Praise for Hedge Fund Analysis "A comprehensive and thoughtful, step-by-step guide to finding, evaluating, and performing due diligence on hedge funds, written by a seasoned professional. With its practical, real-life examples and its valuable insights into the industry, it should be a must-read for investors interested in hedge funds." —Frank Brochin , Chief Investment Officer, StoneWater Capital LLC " Hedge Fund Analysis is a clear, concise, and thorough review of the due diligence process and serves as an excellent guide for anyone looking to identify talent in this opaque corner of the investment universe. The book provides a valuable introduction to a complicated exercise for those new to the industry and is an excellent refresher for the experienced analyst." —D. Jeffrey Dramstad , CFA, Director, Investment Strategy and Due Diligence, Clark Enterprises, Inc. "Conducting thorough analysis of all aspects of a hedge fund can be a challenging, multidisciplinary exercise. This book provides a great introduction for investors seeking to evaluate both investment and operational risks in hedge funds, and highlights the importance of detailed operational due diligence." —Jason Scharfman , Managing Partner, Corgentum Consulting, LLC "Travers provides a comprehensive, yet accessible guide to hedge fund analysis that belongs on the reference shelf of any investor." —Meredith Jones , Director, Rothstein Kass "Hedge Fund Analysis is a thoughtful, thorough book on the hedge fund industry and manager selection process. Travers explains in plain English and great detail the difficult process of finding and selecting a strong hedge fund manager. This book is a must-read for anyone trying to select a hedge fund manager." —Christopher Ainsworth , President, California Hedge Fund Association

Introduction xi PART ONE Background CHAPTER 1 Hedge Fund History 3 So Who Invented the Hedge Fund? 4 The Samurai 4 The Academic 5 The Legend 14 The Innovator 17 CHAPTER 2 Hedge Fund Asset Class 29 Definition 29 Hedge Fund Structure 31 Hedge Fund Strategies 32 Advantages of Allocating to Hedge Funds 43 Hedge Fund Size and Age Impacts Performance 52 PART TWO Hedge Fund Due Diligence CHAPTER 3 Due Diligence Process 57 Key Areas of Focus within Each Component of Due Diligence 57 The Due Diligence Process Highlighted in This Book 60 Putting It All Together 67 Some Initial Thoughts 70 CHAPTER 4 Initial Data Collection 77 Data Collection 78 Due Diligence Questionnaire (DDQ) 80 Fictional Capital Management 80 Other Materials 106 Further Analysis 108 13F Analysis 116 Hedge Fund Journal 119 CHAPTER 5 Initial Interview 121 Initial Call or Meeting 121 Phone Interviews 122 Meeting Notes 139 CHAPTER 6 Quantitative Analysis 145 Performance Measures 146 Absolute Return Measures 146 Absolute Risk Measures 154 Regression–Based Statistics 164 Peer Group Analysis 168 CHAPTER 7 Portfolio Analysis 173 Attribution Analysis 174 Fundamental Analysis 189 Evaluating Portfolio Data 193 CHAPTER 8 Onsite Interviews 217 Onsite Meeting Strategies 219 One–on–One Meetings 219 Meeting with More Than One Person 222 Different Perspectives 223 Meeting Notes 224 Onsite Interviews at Fictional Capital Management (FCM) 228 CHAPTER 9 Operational Due Diligence 259 Case Study: Bayou Fund 259 Definition 261 Importance of Operational Due Diligence 263 Categorization of Operational Due Diligence 267 Interview with FCM Operational Staff 301 CHAPTER 10 Risk Due Diligence 309 Graphical Depiction of Hedge Fund Risks 312 Risk Due Diligence 314 Factor Decomposition Analysis 330 Interview with FCM Risk Manager 333 CHAPTER 11 Reference and Background Checks 339 Onlist and Offlist References 340 Internet and Social Media 341 Contacting References 343 Problematic References 346 Whose References Should You Check? 349 How Many Reference Calls Are Enough? 350 Background Checks 352 Summary of Reference Calls for FCM 353 CHAPTER 12 Hedge Fund Scoring Model and Decision Making 357 Hedge Fund Scoring Model 358 Putting It All Together 374 About the Author 379 Index 381

FRANK J. TRAVERS, CFA, is a portfolio manager at Larch Lane Advisors. He has over two decades of experience analyzing traditional long-only, private equity, and hedge fund strategies. Previously, he was the director of research at First Peninsula Capital and a portfolio manager at Pine Street Advisors and CIC Group. Additionally, he held positions as the director of due diligence at CIBC World Markets, associate director of international equity research at Evaluation Associates, and senior analyst positions at Morgan Stanley Asset Management and RCB Trust. Travers is the author of Investment Manager Analysis: A Comprehensive Guide to Portfolio Selection, Monitoring, and Optimization , also published by Wiley. He received his BS in finance from St. John's University and his MBA from Fordham University.