CFM Due Diligence & Fund Selection 3

Question 1

A fund of funds manager is conducting due diligence on an underlying hedge fund. Which factor most directly addresses 'key-man risk'?

Accepted Answer

Whether succession plans exist if the lead manager departs

Answer

Key-man risk is mitigated when a fund has clearly documented succession plans and a team-based investment process not solely dependent on one individual.

Question 2

In quantitative fund analysis, maximum drawdown is most useful for assessing which risk characteristic?

Accepted Answer

The worst peak-to-trough loss experienced over a period

Answer

Maximum drawdown captures the largest cumulative loss from a peak, directly reflecting downside risk and the magnitude of potential loss an investor could face.

Question 3

Which of the following is a 'red flag' in a hedge fund's audited financial statements during due diligence?

Accepted Answer

Auditor's qualified opinion on valuation of Level 3 assets

Answer

A qualified audit opinion on Level 3 asset valuation suggests the auditor could not fully verify hard-to-price assets, indicating potential valuation risk.

Question 4

A fund charges a 2% management fee and 20% performance fee with a hard hurdle rate of 6%. If the fund returns 10%, what is the performance fee base?

Accepted Answer

4% of total AUM (returns above the hurdle)

Answer

With a hard hurdle rate, performance fees apply only to returns exceeding the hurdle, so 10% - 6% = 4% of AUM is the performance fee base.

Question 5

During fund selection, a due diligence checklist includes a review of the fund's trade reconciliation process. What specific risk does this address?

Accepted Answer

Operational errors and unauthorized or erroneous trades going undetected

Answer

Trade reconciliation ensures that positions recorded by the fund match prime broker and custodian records, catching operational errors and potential fraud.

(CFM) Certified Fund Manager Practice Test

(CFM) Certified Fund Manager Practice Test

CFM Due Diligence & Fund Selection 3