Manager Relationships

Operational alpha: The evolution in fund manager due diligence

Asset owners who assess their outsourced fund managers are facing mounting challenges that mean emerging tools, such as AI, are key to successful operational due diligence. takes a closer look at the responsibilities and skillsets of those conducting ODD and why it’s core to a successful investment function. We speak to ODD specialists at APG, Australian Retirement Trust and Local Pensions Partnership Investments in London.

Rigorous operational due diligence (ODD) is a cornerstone of managing relationships with asset managers, as well as being a critical tool in both maximising returns and minimising risk to investors’ capital. 

At the end of the day, an ODD team stands between a great investment idea and a potential operational disaster. And while asset managers can seek to dazzle investors all they like with smart investment theses and cherry-picked investment performance, they’ll quickly run into a brick wall of ODD practitioners who care little for egos, and even less for reputations. 

An ODD team stands between a great investment idea and a potential operational disaster

ODD specialists exhibit a healthy level of scepticism towards what they’re told by asset managers, and willingness to dig deep into a manager’s business to see for themselves how it’s structured and how it works. 

“I want to know how the business is run, not how they want to outwardly project themselves,” says Kevin Eastwood, head of operational due diligence at the £25 billion ($31.8 billion) Local Pensions Partnership Investments.  “I’m into practicalities. I’m an ops person – I want to know how it’s run.” 

A good ODD process generally won’t on its own improve returns, but LPPI chief investment officer Richard Tomlinson – to whom Eastwood reports directly – has observed that “deep and detailed ODD underpins a solid investment process and provides CIOs with an additional, critical risk control; return of capital is more important than return on capital”. 

ODD looks past investment returns and the performance claims of asset managers to take a cold, hard look at the quality of the governance, controls, processes, and systems underpinning the manager’s business and investment strategy. 

“Our role is to assess a manager, to do a risk-based assessment of a manager, on their operational controls and functional areas,” Eastwood says. “It’s literally from the moment the manager has an idea. From the point that he executes that idea we’re looking at the governance, we’re looking at the controls, we’re looking at the systems; and we will follow that transaction through the entire process: how it’s settled and how payments are made; how does it get communicated to the service providers; how is it reported; how the compliance people look at it; how the risk people look at it – all the way through to investor reporting.” 

When ODD works, it supports asset owners in selecting managers unlikely to come unstuck through some sort of business or process failure. When ODD doesn’t spot the red flags, it can lead to the loss of investor capital and incalculable reputational damage to the asset owner. 

Global head of operational due diligence for the €569 billion ($617.3 billion) APG, Michiel Vetkamp, says the fund’s portfolio managers focus on the asset manager’s investment proposition, whereas the ODD team focuses on “the operational profile of a firm you’re engaging with”.  

“That can be an external investment manager. In our case, it can also be what we call a direct private investment,” Vetkamp says. “That’s usually a corporate such as a wind farm, a hotel, or something else. Obviously, we want it to be a solidly organised firm.  

“Our perspective is more the operational perspective. The PM usually starts with the investor proposition; we are more looking at the downside, that the firm is really solidly organised.” 

Vetkamp says the APG team conducts ODD on managers in all asset classes where APG has externally managed money and conducts the process globally. 

For some asset owners, ODD is a major undertaking. Australian Retirement Trust senior operational due diligence specialist Andre Kopiec says the A$260 billion ($171 billion) fund has money invested with around 260 external managers across all asset classes, and every manager receives an attestation or a “small health check” from the ODD team at least every year. 

“We also do look at managers on a risk-based approach, where we will do what we call either a desktop deep-dive, or an onsite visit,” he says. “It means that over a four-year period, those managers will at least have had a deep dive.” 

New and emerging challenges 

Asset management is dynamic and complex, and the ODD specialist is constantly faced with new and emerging issues to grapple with. 

“Cybersecurity is top on the list,” Eastwood says. “It’s an ever-moving feast. In regulation, things are changing so quickly. The great thing at the moment is the SEC [Private Fund Adviser] reforms – that’s going to change [things] about transparency and valuations. We need to figure out how we do that. 

“We work with our RI team. Obviously, the investment team are asking about ESG; so are we. Are we asking the same thing? No. They’re asking about strategy; we’re asking about the manager. We want to know how they run the business.  

“We also ask about diversity and inclusion. That’s becoming a big-ticket item.” 

Vetkamp says the role of the due diligence expert is “is ever-evolving”. 

“What you see is that [on] some risks, our risk view is changing over time,” he says. “If you look at information security – that’s fraud, perhaps the most important one – every organisation is becoming more vulnerable to information security, cyber-crime, et cetera. That has become more and more an important focus.  

“In the past, we always looked at IT. Then, we looked at IT governance, IT control environments. But nowadays, we spend much more time asking specific questions about do you have vulnerability software detection software, do you perform penetration testing on IT? Is that mandatory? Do you do it on an annual basis? Is it on a rotating basis with different providers? All that kind of stuff. Information security has become more and more important.”  

Kopiec says the starting point for most ODD processes is a questionnaire sent to an investment manager. But even the questionnaire – its structure, the issues it canvasses and how the data is collected from the managers – has evolved. 

“If I go back to when I started, information security, was quite minor,” he says. “Today, it is a core component of what we look at. For investment managers we are looking at the framework, the controls to make sure they’re robust, and they can meet the regulatory requirements as put out by the regulator.  

“It’s probably gone from two or three questions to a lot more, in terms of framework process control. So, in that respect, your questionnaire will change also,  

“The way that we’ve looked at how we invest with managers also impacts the question, affects the questionnaire. And the final one probably, is that internally, as a group, we’ve discussed whether or not the questionnaire is fit for purpose.”  

ODD in a time of automation and AI 

A certain amount of ODD work is automated or at least mechanised, such as collecting information from asset managers via questionnaires. However, the use of AI to streamline the process is only now beginning to emerge. 

Vetkamp says APG launched an in-house-developed ODD tool in late 2023. 

“It has brought more control. Efficiency is still a purpose, but if I’m really honest, so far it is primarily focused on additional control and having a uniform standardised methodology,” he says.  “It’s what we call an ODD workflow management tool, where it guides the PM or the ODD experts through the whole process of ODD, via an automated mechanism.” 

Vetkamp says that in the analysis and reporting phase of the ODD process the APG tool has an embedded risk control framework which “triggers you to think about what kinds of risks and controls are important for this type of assets class and this type of manager”.  

“The first step in ODD is a due diligence questionnaire. The tool also enables us to make that much more tailored. Basically, what we do when we start is that we define the asset class but also some specific manager characteristics – so how mature is the manager? Is it only in developed environments or is it also in less developed countries? 

“That enables us to make the ODD questionnaire much more tailored before we send it out.” 

To date, AI has played only a small role in how both APG and LPPI conduct ODD, but Vetkamp says APG is developing a screening tool based on AI that will scour the world’s news sources to bring to its attention anything it needs to know about the managers it has placed money with. 

“We have selected an external data provider, who is basically collecting all the news, and that’s huge, the universe of news is huge,” he says. 

APG is developing a screening tool based on AI that will scour the world’s news sources for news about the managers it has placed money with

Eastwood says technology is embedded in the process to some degree now, but he expects that it will make further inroads, particularly the application of AI to sorting through large volumes of information. 

“We’re testing some AI and how that can work,” he says. “Can it do what I need it to do now? No. Could it? I think so. We have to be careful how we ask AI the questions for it to go back and look for. 

“The application that I see at a local level, potentially, is could I point AI, with my questionnaire, to a certain set of documents and ask AI to go into those documents and answer those questions for me?” 

Vetkamp says a welcome AI-based development would be to help organise the provision of information about asset managers. 

“What I’ve seen in the market is there are some initiatives where firms basically collect all kinds of information from investment firms so that they can easily offer it,” he says.  “They have huge questionnaires with standard responses available, which are being updated all the time. I think it’s now really still at the early stages, but it may be quite nice evolvement actually, if that happens, that you could reach out to such an organisation for all the up-to-date information, basically, and that you would get it instantly.” 

Kopiec says that ODD is a data-intensive activity and while technology has played some role in making the process more streamlined there is further work to do. 

“It doesn’t matter who you talk to, there’s a questionnaire that needs to be sent out in need to obtain information back from a prospective investment manager,” he says.  “What’s changing is how information is gathered and collected, and that’s a journey, which is still evolving. To this day, whether it’s through a consultant or through industry, market participants, how you can obtain information in the most effective manner and be able to analyse it is what we’re still working towards.” 

Change keeps it interesting 

Kopiec describes ODD as the ability to look dispassionately at an investment manager “through an independent lens to ensure that it aligns with ART’s risk appetite”.  

“We’re independent of the investment team,” he says.  “We provide the independent colour to the investment team and the relevant committees, so they can factor that into their practices. We have an independent review or control framework…so it’s not influenced [by the investment team]. 

Kopiec says a big part of the challenge of ODD, and the pleasure of doing it, comes from the fact that “it is a constantly changing landscape”.  

“If I think about what it looked like when I first started [compared] to today, the reason why I like to do it is because it continues to evolve,” he says. “Whether it’s through ART’s growth, to the investment managers, to the regulatory landscape, each has a challenge. That’s what continues to drive people in ODD, because it doesn’t matter whether you look at a manager today, compared to three years ago it’s not the same lens, it will have changed.” 

Typically, an asset owner’s ODD process kicks in after its investment team has already determined that it needs to hire an external asset manager, and often the investment team will conduct some investigations and can weed out managers that are obvious non-starters before handing over the task for a deep dive by the ODD specialists. 

“We then will work with the team to understand whether or not that manager is going to proceed; only at the point where that manager is going to proceed would we then start the due diligence process,” Kopiec says. 

“The way that I would look at it is if you use the funnel approach, where you have a large number of investment thoughts, distil that down to where you get to the [point] we’re going to move forward; and we then get engaged with the relevant asset classes to start that process.” 

Vetkamp says APG’s portfolio managers have long been involved in ODD, but in 2017 it made ODD a centralised and specialised activity. 

“And to be honest, since that time we have continuously been working on what we call the ODD framework,” he says. 

It’s a two-way street 

LPPI’s Eastwood notes that ODD creates a virtuous circle. It gives an asset owner confidence in the business models and structures of the asset managers it hires, but it can also deliver valuable feedback to asset managers to help them improve systems and processes, which is good for asset owners. 

“Part of the discussion that we have with the manager is we say to them, we’re not here to play gotcha. That’s not our job. We’re not consultants. We’re not being paid by the amount of red flags that we find. We’re not there to discount them, we’re there to see if we can invest with them in a safe and secure environment.” 

Eastwood says feedback commonly takes the form of comparing a manager’s processes and structures with what LPPI sees across the market, and what it considers to be best practice. 

Feedback commonly takes the form of comparing a manager’s processes and structures with what LPPI sees across the market

“We sit in front of 30 managers a year; these managers don’t,” Eastwood says.  “Our knowledge and our information is valuable. We give that back and the managers appreciate it. 

He says there is rarely a single flaw or shortcoming in an asset manager’s business operations that turns out to be a complete showstopper, because such managers are not likely to get past the investment team to start with. But there are some common red flags that prompt closer attention or discussions with a manager. 

Typical warning signs may include “inadequate controls; and risk-management systems where I can’t see how they control the business, how they’re monitoring risks, how they’re doing any risk-assessment of the business”, he says. 

“And lack of transparency around fees, valuations, controls, or where they say, ‘oh no, we don’t share that’. Why? OK, talk to me.” 

Kopiec says ART has always “taken a collaborative approach with all investment managers, whether we proceed with them or not.”  

He says the fund has a core set of expectations of any manager it considers working with, around organisational structure and people, internal controls and assurances, and operations and IT. It makes these expectations clear at the outset of any engagement and is prepared to work with a manager, within reason, to remediate any issues it may find before committing capital. 

“If a manager was below what we would consider to be a minimum threshold, then that is where we would escalate those issues through internal review, and from that determine whether or not they could be remediated prior to appointment,” he says. 

“We would have discussions with the investment team, and with the investment manager, to determine whether or not they were willing to take on board ART’s feedback, and maybe implement what we’ve said. 

“We will not just tell the manager ‘no’ per se. I’m quite happy to say that in the last five years, there’s only been one manager we’ve said no to, and that was simply because the manager was going to take a lot longer to remediate the issues in the timeframe that we were prepared to accept.” 

Being taken more seriously 

APG’s Vetkamp says asset owners’ focus on ODD has become more significant in the past few years and that “over time, it’s being taken more seriously” by investment teams and senior management ranks. 

“I think originally, the Netherlands, Canada and Australia were the main countries that devoted a lot of attention to ODD, but what I see now happening is that many more institutional investors from other jurisdictions are also starting to have ODD professionals, dedicated teams, et cetera, to look at it,” he says. 

Vetkamp says that while it may be true that the volume of funds placed by some asset owners with external asset managers has increased – placing more capital at risk of events such as fraud – one other driver is “also the regulators, who are also asking more questions about ODD when they do their regulatory investigations”. 

“If you outsource something you are still somehow responsible, so you have to demonstrate that you’re outsourcing to a solid party, and you also need to be able to demonstrate this to the regulator,” he says. 

LPPI has three full-time ODD specialists and has an outsourcing arrangement to a specialised external consultancy to handle overflow and “they can, under [our] permission, go and perform an operational due diligence on our behalf. 

“We also have with one of these consultants a 20-days secondment environment, where if need to I can pull somebody in from this business and drop them into my business for 20 days,” he says. 

To date the LPPI team has been focused on assessing new managers to add to its line-up, and Eastwood says it is preparing a program to systematically review incumbent managers. 

APG has eight ODD specialists: seven in Amsterdam and one in New York, with a ninth soon to be added in Hong Kong. 

“The APG ODD team functions as a global team, with a global pipeline and globally uniform processes and systems,” he says. 

“And to be honest, we have more business, more flow, than that the person in Hong Kong can absorb, so in that sense the team in The Netherlands will still help. And basically, the same goes for US.” 

Vetkamp says APG’s ODD team is “positioned in the first line of defence, we are residing as part of the chief investment officer”. 

“We also have some ODD professionals in the second line, in risk management, who basically look at our work…and also form their own opinion as part of risk cycle for the investment committee, if new investment proposals are being prepared,” he says. 

LPPI’s Eastwood says some asset owners locate ODD specialists in their risk operations, but he says they function better when treated as part of the investment team. 

“The reason why it works better is Richard [Tomlinson] was at Albourne Partners and understands what ODD is. And he believes that this is part of the investment team, because we’re part of the investment decision process. I hadn’t thought about it like that before; I would have thought it’s a risk-based approach. It is, but this way works so well because you’re embedded into the decision process. In my opinion, it’s the best place for them.” 

ART head of investment operations Antony Gold says the fund’s ODD team is part of a 70-person investment operations team that ultimately reports to the fund’s chief financial officer, unlike the ODD teams in LPPI and APG, who report to the CIO. 

“There’s very much are two schools of thought out there, and we’ve obviously gone for the segregated model,” Gold says. 

“Our workload is more aligned to the CIO than to the CFO, but from a segregation of duties perspective it’s not only ops due diligence we do, we do performance and data reporting, which the investment team is remunerated off. We…govern the investment data to make sure that…there’s independence from people who might benefit from that.” 

“We’re not aligned to the investment team, we’re there to make sure we’re aligned to the fund as a whole, and we’re making the right decisions, and we’re not part of a team that is driven towards making an investment.” 


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