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Operational due diligence asks whether an investment manager can keep assets, records and reported values reliable while pursuing its strategy. For an FRM Part II candidate, the key distinction is between judging the investments and testing the people, documents and independent checks around them. Strong historical returns do not answer who priced a hard-to-value holding or who could change that price. The CFA Institute manager-selection reading likewise places operations and infrastructure in the due-diligence assessment.
Follow the number back to its source
Begin with a reported net asset value and trace the process that produced it. Find out which holdings have observable prices, which need estimates, who proposes those estimates, and whether a separate party checks them. An external administrator helps only to the extent that its calculations and challenge process are independent; an informal manager override can undo that protection.
Next, compare the administrator's records with the custodian's asset records and investigate breaks. Ask who authorises trades, who settles them, and who reconciles cash. Separation matters because the person able to create a transaction should not be the sole person confirming that it occurred. The Basel Committee's operational risk guidance discusses separated duties and independent review for banks; here the same questions are used as a diagnostic for a manager, not as a claim that bank rules govern the fund.
An illustrative file review
Suppose an invented fund reports a portfolio worth £100 million. Its independent administrator initially values one illiquid holding at £20 million, but the manager raises that mark by 10% without a recorded reason or outside approval. The extra £2 million raises the reported portfolio value to £102 million, or 2% above the initial figure. This is an illustrative control test, not a market observation or proof of wrongdoing.
The due-diligence response is to request the original price inputs, the override log, the person who approved the change, and the administrator's revised calculation. If those items do not exist, the issue is the absence of a reliable check on a discretionary mark. Recalculating the return alone would simply repeat the unsupported input.
Check whether written controls operate
A policy manual tells you what should happen. Exception reports, reconciliations, control testing and records of resolved breaches tell you more about what did happen. Compare the fund's offering terms with subscription and management documents, particularly around fees, liquidity and the manager's authority. Review the financial statements and their notes for related-party arrangements and inconsistencies with the stated strategy. Confirm the actual roles of the administrator, custodian, auditor and other providers rather than treating their names on a document as evidence of oversight.
GARP places investment management within the FRM Part II study material. When revising this area, use the FRM program overview to keep the risk-management context in view, then use the Omni methodology page as a route back to structured practice.
The exam mistake to avoid
Candidates often treat the existence of a control as evidence that it worked: an administrator is named, an audit occurred, or a policy is lengthy. Ask instead who had final authority, what independent evidence survives, and how exceptions were resolved. Operational due diligence is a judgement about the reliability of the process behind the reported result.
Sources
- FRM Study Materials · garp.org · Retrieved
- Operational risk · bis.org · Retrieved
- Investment Manager Selection · cfainstitute.org · Retrieved
