Importance
The historical position is somewhat odd given the prevalence of operational risk failures in, for example, hedge fund scandals and closures over the years. As early as 2003, a study by Christopher Kundro and Stuart Feffer of Capco indicated that operational risk failings were the sole reason for 50% of all hedge fund failures (with operational risk failings being a contributing factor in other failures as well), rather than bad investment decisions alone (38%), and anecdotal evidence seems to imply that (i) the impact of operational risk is at least as pervasive in other (non-hedge fund) types of alternative investment funds, and (ii) that the impact of operational risk failings has not decreased since the Capco study.
A 2008 book by Jason Scharfman of Corgentum Consulting suggests that operational risks are inherent contributing factors to all hedge fund failures.
For example, a May 2009 derivative lawsuit relating to a feeder fund invested in a managed account that was exposed to Madoff’s split strike conversion strategy noted that “the Madoff story bristled with red flags that a financial professional firm performing an evaluation and subsequent management and oversight, in good faith, could not have missed.”
The clear implication of this statement is that in the absence of detailed and robust pre-investment and on-going ODD, investors simply missed the operational risks inherent in the structure.
Read more about this topic: Operational Due Diligence (alternative Investments)
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