Frequently Asked Questions

The operations of an investment manager should follow best practice standards and adhere to the relevant regulatory requirements for the manager.

The following FAQ has been created to assist managers (and investors) understand the established best practice standards for their operational and compliance controls.

FAQs for Operational Best Practice Standards

Should investors seek to understand the structure of the fund and the manager?

Understanding the legal entities involved in the operations of the fund, such as the manager and the fund itself, but also any group entities, e.g. branches, offshore management companies, general partners, service companies, etc. is very important as the controllers of the companies control the money and thus any risk lies with these entities and their management.

How do I know how to review a corporate structure?

The simplest way to review a corporate structure is using a group chart usually provided by the manager and then corroborating any information on it against other documents (such as the fund prospectus) or information publicly available (such as from the registrar of companies).

What details should I look for in an investment management or an investment advisory agreement?

The manager, and any sub-managers or investment advisors, should be subject to a formal investment management or advisory agreement. Further, if a third party has been appointed as the entity responsible for significant functions such as portfolio management, the agreement should specify which entities are responsible for which activities. In addition, the delegating party should retain supervision duties and monitor the third party. This is all written out in the agreements; their role and their duties. This gives you an insight on how responsibilities are spread out. Understanding this as well as potential fee flows and ascertaining the parties (especially if the parties are related) and the transparency of the relationships is key to establishing a relationship of trust.

What kind of governing body should the fund have?

Typically a structure with a board of directors that has a majority of independent directors offers the most security to investors. Where the structure is a limited partnership with a general partner, the general partner’s board should be considered as the governing body. Further, in private equity and real estate contexts, for example, independent governance is often represented by a limited partner advisory committee (LPAC) or similar.

Should the fund have investment restrictions?

In relation to certain investment products, such as a UCITS funds or listed funds, the applicable regulations require the establishment of specific limitations. However, even in the absence of such regulations some good practice limits for the manager’s remit should be established within the offering documents. Legally unenforceable risk profiles, which may be stated outside of contractually binding offering documents, are not sufficient to be considered investment restrictions.

Should side letter agreements be disclosed?

Yes. If the manager has entered into or plans to enter into any side letter agreements, the details and any preferential fees, terms and conditions of such arrangements should be disclosed to potential investors. This is also a requirement under the EU’s Alternative Investment Fund Managers Directive.This is so that any investor is given comfort that there are no conflicts that may lead the manager to behave in a certain way for some investors and not others.

How should the performance fees or carried interest be calculated?

These fees should reflect the long-term performance of the fund and should only be realized when the performance exceeds an established and constant high-watermark or hurdle rate. Anything else is probably too generous for a manager and may lead to a lack of intent towards better performance, especially when management fees are high or large due to amounts of assets under management, which benefits the manager but not the investor.

Can the fund restrict redemptions?

Yes. In the case of open-ended funds, lock-ups, gates and NAV suspensions can place restrictions on potential redemptions. Investors should refer to the offering documents to ensure there is specific provisions as to when and how such restrictions are imposed. Where the fund trades liquid assets, it is questionable whether an investor should be comfortable with redemption restrictions, but best practice does recognize that market conditions may be such that some restrictions do apply. Funds in more regulated jurisdictions will need the avail of the regulator to enforce such restrictions, which may provide more comfort for investors.

Should the fund have leverage and borrowing restrictions?

The offering documents should include provisions that define the use of leverage and borrowing and state the maximum limit that can be applied by the manager. Anything more open than that largely plays into the hands of the mangaer and is a poor reflection of their understanding of risk.

Why is the Total Expense Ratio an important indicator?

A total expense ratio helps determine the cost of an investment in the fund as a percentage. It is achieved by calculating the total operating cost of the fund (inclusive of management but exclusive of performance fees), divided by the fund’s average net assets. It is important as it shows whether costs are legitimate and fair or appropriate.
Where it is deemed too high it raises issues such as whether the manager is aware of how to manage costs – after all the money belongs to investors and to show some business acumen to limit costs should reassure investors. If they are high,
they may also reveal expenses, which, upon closer examination, are not deemed appropriate and may even reveal serious conflicts of interests.

Should the fund have Soft Dollar Agreements?

Soft dollar arrangements, for services such as research, can provide a benefit to an investor, but at the same time they create conflicts of interest that compromise best execution policies and the fiduciary responsibility a manager has to its investors. In order to ensure that soft dollar arrangements comply with jurisidiction-specific regulations and are conducted in a consistent, fair and equitable manner, the manager should have formal policies and procedures in place for when and how soft dollar arrangements may be leveraged. From 2018, these will be banned in many cases in Europe, but funds managed under UCITS and AIFMD will remain capable of having soft dollar arrangements. The key for investors is to understand them and for managers to explain them.

Is staff turnover in the manager relevant?

Senior management turnover can unsettle the operations of the manager and have implications on the fund and its investors. It is therefore important to ascertain any prior staff turnover and seek to determine whether there are any reasons for potential turnover which may still affect the manager.

Who is considered a key person at an investment manager?

If an individual’s departure would cause significant disruption to the business, that individual should be recognized as a key individual and appropriate protection should be provided to investors in the event of such a departure.

How should the fund's IT infrastructure be protected?

All critical data, including trading and investment data (as well as the hardware and software used for the operations of the fund), should be replicated and stored in a redundant location. Real-time, or near real-time, redundancy of data provides the best safeguard for investors and enables the manager to failover to its redundant location and data if there is an interruption at the primary location/data center.

Who should do the valuation of assets and calculation of NAV?

The Administrator should be responsible for the valuation of assets and the calculation of the NAV without the involvement of the manager. If there are hard-to-value or illiquid assets it is preferred that an external valuation agency assists the administrator in valuing such assets. If the manager is involved in the valuation of assets, it should provide evidence to the administrator to justify the valuation which the administrator can scrutinise.

How should trade confirmations be handled?

All investment confirmations should be sent to the manager and the administrator by the executing party to ensure that the administrator receives all trade confirmations directly from an independent party.

Should the fund appoint a Prime Broker, a Custodian, and a Depositary?

The appointment of a prime broker, custodian or a depositary will vary depending on the strategy in question as well as the regulatory requirements to which the fund is subject. A fund may have all three (and for all three to be separate providers) or none, although investors should not forget that cash should be custodied through a traditional banking relationship. Any service provider relationship should be governed by an agreement between the fund and the third party and the agreement should be made available to investors for their review.

What provisions should be in place for cash transfers?

Cash transfer policies are an essential consideration in ODD. A manager’s cash transfer policy should require at least two approved signatories to authorize a cash transfer from the fund’s accounts to third parties. A minimum of two signatories, ideally from segregated functions, helps prevent unauthorized cash transfers. Further, cash transfers should require the administrator (where relevant) to countersign or separately approve any cash movement, so as to provide an additional layer of independence.

Should the fund make use of order/ execution management systems?

Where possible, all investments and orders should be processed through an established and controlled order management or execution management system (an “OMS” or “EMS”). Submitting trades through such a system provides a centralized system for investment processing, a reliable audit trail and enables the manager to automate and control its investment compliance and allocation functions. In our view, the use of a good system for portfolio management applies equally to liquid as well as illiquid strategies, even if their functions are somewhat different.

How should the middle/back office be segregated?

A manager should have in place a segregated middle/back office function responsible for the matching and reconciliation of investments, as well as for the fund’s accounting. In addition, the middle/back office should have sufficient authority and should therefore avoid a structure where the team reports to the portfolio manager or chief investment officer.

How should reconciliations occur?

Where appropriate, the back office’s reconciliation process should be a three-way process between the manager, the broker(s) and the administrator. The reconciliation process should seek to automate the reconciliation process through data feeds and/or other confirmation data provided by the executing party.

Who should review and approve the NAV produced by the administrator?

The individual(s) responsible for approving the NAV should be independent of the investment process to minimize conflicts of interest. While there is no mandate regarding the role/function that confirms the NAV it is common for the head of back office or the chief financial officer to assume this responsibility. It is important to put that person in a position of trust, as the administrator is contractually mandated most often to take that sign off as final authority of the NAV.

What is the role of a risk committee at an investment manager?

The manager should establish a risk committee to provide the management oversight of the risk function. The Risk Committee should have a suitable level of independence from the investment function and should consider not only investment risk, but also operational and counterparty risk. The risk committee should keep formal written records of the committee’s discussions and actions. If it has no records or a limited scope of review, investors should be cautious as to whether it is efficient at all.

Should a manager perform due diligence reviews on its service providers?

Service provider due diligence is a regulatory requirement in many jurisdictions. As such, managers should ensure that they have defined process in place to regularly review and evaluate their key service providers.

How often should the manager review its compliance systems and controls?

It is expected that a manager reviews its compliance systems continuously and provide a comprehensive compliance review on at least an annual basis. Further, there are regulatory requirements that require a manager to review their compliance controls and infrastructure and file certain results with the regulator. It is important to understand this well to test the manager accordingly and provide comfort that compliance and controls are in place to protect investors and the business of the manager.

Latest from the Newsroom


GDPR in full force days after deadline

The GDPR is, at the time of writing, exactly 6 days old and some of (more...)



THE BROKER DEALER QUESTION Micah A. Taylor for Institute of Compliance Accessing US Capital private (more...)


GDPR: Does your company need an EU representative according to Article 27?

The General Data Protection Regulation (GDPR) is set to come into force on 25 May (more...)