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

Chapter 9

Operational Due Diligence

“Nothing is so firmly believed as that which we least know.”

Michel de Montaigne

“The greatest obstacle to discovery is not ignorance—it is the illusion of knowledge.”

Daniel J. Boorstin

When we think about the myriad number of things that can cause a hedge fund to fail, what immediately comes to mind are issues surrounding the investment professionals, process, and fund performance. When investors analyze a hedge fund, they tend to focus on the return they expect from the hedge fund in the context of the underlying fund risk. After all, very few hedge funds are hired because they employ multiple offsite data services or because their compliance manual is particularly well written. However, operational due diligence (ODD) is a critical aspect of hedge fund due diligence. The following case study is a perfect example of why ODD is important.

Case Study: Bayou Fund

While there are many good examples that illustrate the importance of operational due diligence, the plight of Samuel Israel III, Daniel Marino, and James Marquez is quite remarkable and reads more like fiction than fact. The story of Bayou Group is a cautionary tale of hedge fund fraud involving falsified pedigrees, fake auditing results, clear conflicts of interest, multiple staged suicides, fictitious investment returns, international intrigue, and a nationwide manhunt.

Sam Israel III ...