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A due diligence platform for cryptocurrencies attracts family offices

All too often, family offices find compelling investments in esoteric markets but fail to invest at the last minute for fear of being swindled out of their money. 

This abundance of caution can be reckless. Crypto-currency hedge funds have risen 54,000% since 2013, according to a Eurekahedge index. Family offices have benefited from an exposure but not as much as they ought. 

Crypto funds all tend to suffer a similar set of weaknesses and deficiencies. But they have a willingness to improve themselves and keep up with the requirements of institutional investors

To help out, a new adviser called PerFORM offers an operational due diligence service. Where red flags exist, it seeks to negotiate their impact so clients can sleep at night.

It was started in 2019 by James Newman, ex-head of due diligence at Barclays Wealth, and Quentin Thom, who led hedge fund consulting at Deutsche Bank’s prime broking arm. They recently sold the business to JTC Group, a UK listed adviser, led by family office adviser Nigel Le Quesne. 

Newman and Thom have spent their career in operational due diligence. In 2008 Newman worked at Liberty Ermitage, where he vetoed the use of funds run by the late fraudster Bernard Madoff.

Large institutions retain their staff to carry out due diligence, but they often need to hire an expert when new sectors open up.  

Family offices more often use third-party due diligence or ask their consultants to take the job. But consultants can get stretched.

According to Thom: “We saw a surfacing of tension around the delivery of these services by incumbent groups. It was at a point where the frustration was enough to make us think we could really shake things up.

“We felt investors needed more choice than they were going to get with an investment consultant, where you potentially have to get involved with portfolio construction and everything else that goes with it.” 

Consultants have a backlog of work, and charge by the hour: “We thought it would be much smarter for investors to call up a group like us, and get timely advice for a fixed fee.”  

Clients ask PerFORM to carry out due diligence for a fixed fee near the end of a fund selection process. 

Thom says: “Operational due diligence is a tool for enabling opportunities. It shouldn’t be used as a weapon to veto everything and miss out on them.”

PerFORM looks at a broad range of funds but crypto has been its biggest opportunity. It not only carries out due diligence for investors but advises managers keen to tick the right boxes to win new business. 

The service is called ODD Therapy. PerFORM is currently putting together reports for crypto virtual asset service providers such as exchanges, expressing views on the quality of their governance.

“We’re reviewing an explosively growing multi-billion exchanges that have enlarged with huge complexity and no regulation.  When the reports are finished, they’ll be able to review them for factual accuracy, but they won’t be able to change our criticisms.”

Operational due diligence ends up playing a more important role than you might think in the development of new markets.

According to Thom: “Crypto funds all tend to suffer a similar set of weaknesses and deficiencies. But they have a willingness to improve themselves and keep up with the requirements of institutional investors.”

Family offices have been the early movers in backing crypto funds, he adds: “They’re nimble. They don’t have the same bureaucracy as institutions.”  Whatever their reservations about governance, many families have enjoyed their early mover advantage, as money flowed into the sector.

Returns have moderated now two-way trading has developed in physicals and futures following the arrival of institutional investors. 

The hedge fund movement also saw fast gains in the 1980s when family offices started to take a view. A busier market now means returns have become lower. 

PerFORM sets out to be constructive in tackling its work, expecting to see improvements in administration when they can afford to hire more people.

It has only needed to veto one crypto firm although several of its clients have taken account of its concerns by postponing their engagement or requiring them to write side letters, committing them to better governance.

Thom sees basic data from the outset, whether funds are based in Panama or the British Virgin Islands. But he often finds data on procedures, continuity plans and compliance to be sketchy. Questionnaires need to be drawn up and  unusual activities checked: “You need to see that auditors and lawyers aren’t heavily invested in the firm, and don’t work over a local kebab shop.” 

A few issues keep cropping up. One is the risk of putting too much reliance on the actions of a key individual, although there is a limit to what can be achieved when firms are young. Independent fund directors are rare and the cost of insuring a new business against trading losses can be prohibitive.

PerFORM sets out to assess how a business has been put together and assesses the character of a founder: “It’s all about unpacking someone’s luggage, checking the cleanliness of the clothes, whether they been washed and whether they include real Gucci or a fake.”

Ways of dealing with asset transfers need to be pinned down at an early stage, along with rules on personal dealings: “There’s a need to formalise and prove fundamental controls for any investment manager and fund arranger if they want to attract business.”

 

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