Castle Hall recently surveyed a group of asset managers who had been subject to our due diligence process. The results were stark: 100% of managers reported inefficient duplication in investor DDQ / RFP requests: every manager surveyed reported that at least half of investor DDQ questions overlapped. What is truly surprising is that 60% said investor DDQs / RFPs were highly duplicative, with at least two thirds of the questions asked by their investors duplicating requests from other allocators. It goes without saying that this duplication costs significant time and money for both asset managers and investors.
What is the background? Pre 2008, operational due diligence was a specialized discipline, focused almost exclusively on hedge funds in response to the experiences of Manhattan, then Lipper / Lancer / KL Financial, then Bayou. In the hedge fund space, the first versions of the AIMA questionnaire (first launched as far back as 1997) had good traction as a standard source of information. We note, however, that pre Madoff plenty of hedge fund investors did not complete ODD at all, so usage of DDQs was far from universal.
Madoff (and Petters, Weavering etc.) made ODD mandatory for fiduciaries investing in hedge funds. From 2009, we saw a rapid increase in the number of both in house DD teams and investment consultants completing operational due diligence. This has led, over the past decade, to a proliferation of investors' own DDQ and RFP formats, either using good old fashioned spreadsheets or enabled by one of the various online survey platforms. Also notable is a marked drop in the usage of "standard" industry questionnaires, either because whatever the manager produces investors still demand their own format; because managers develop their own "amalgamated" DDQ document; or because industry questionnaires have perhaps become too lengthy and complex.
Concurrent with changes in hedge fund ODD has been the expansion of ODD procedures across other asset classes, notably in private equity. The (long overdue!) introduction of professional ODD to private markets was largely driven by the SEC's 2015/16 settlements with several large PE firms around disclosure deficiencies and fee issues, particularly with respect to accelerated monitoring fees. And once investors look at PE, then private credit, real estate and infrastructure also fall in scope (let alone venture, despite Silicon Valley's efforts to never fill in anything for anyone just because they invested in Facebook pre IPO!)
In the PE space, ILPA questionnaires are the industry standard, although ILPA is heavily skewed to IDD and, of course, follows a different format to AIMA in the hedge fund market. Moreover, it is much more common for PE General Partners to have their own firm specific DDQ in place of ILPA or another industry group template, making comparison and standardization more elusive.
Adding even more variability, some markets have gone in different directions - in Australia, for example, the Australian Institute of Superannuation Trustees have developed their own ODD framework (recommending a manager pays model for ODD reports). A separate group, the Financial Services Council, has their own DDQ template used by some Aussie investors for both domestic and international allocations.
Taking a step back, several themes emerge.
Castle Hall's response to the evident inefficiency of today's ODD procedures is DiligenceExchange. Our goal with DXC is to empower investor ODD teams to move up the diligence value chain - while saving countless hours for the asset managers / GPs.
Post Covid, we are all being asked to do more with less - and cutting out unnecessary duplication seems to be a great place to start.
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