Questions to Ask Hedge Fund Managers
Questions for a meeting with a hedge fund manager, whether you are running diligence as a prospective investor or sitting down with one professionally. They cover strategy and edge, drawdowns, leverage, fees, liquidity terms, and key-person risk.
The questions
Open any question for the note
What is the strategy in one sentence, and what would have to be true for it to stop working?
Why ask it
A manager who cannot compress the strategy into a sentence either lacks one or does not want you to have it. The second half matters more: naming the condition that breaks the strategy shows they have thought about their own obsolescence.
Where does the edge come from: information, analysis, structure, or patience?
Why ask it
There are only a handful of honest answers, and structural or behavioural edges age better than informational ones. Working harder than everyone else is not an edge, and neither is access to the same filings.
What is your average holding period, and how many positions do you hold?
Why ask it
These two numbers together tell you what the strategy actually is, regardless of how it was described. A manager who calls the approach long-term value while turning the book over every three weeks is doing something else.
How do you size a position, and what is the largest single position you have ever held?
Why ask it
Sizing is where conviction meets risk control. The largest historical position is a hard number that says more about discipline than any description of the process around it.
What is your worst drawdown, how long did it last, and how long did recovery take?
Why ask it
Ask for all three. Depth alone is easy to narrate away; duration and recovery time are what an investor has to sit through, and that is where redemptions actually get filed.
What were your three biggest losing positions, and what changed afterwards?
Why ask it
Every manager has losses, so the signal is whether they can name them specifically and point to a rule that changed. Blaming the macro environment with no process change is the answer to be wary of.
How much leverage do you run, gross and net, and what would force you to cut it?
Why ask it
Gross and net exposure can hide behind one headline leverage figure. The part worth pinning down is the trigger: the loss level or margin call at which they sell because they must rather than because they chose to.
Who is your prime broker, administrator, and auditor, and has any of them changed recently?
Why ask it
Independent administration and a recognisable auditor are basic structural protections. A recent change to any of the three deserves a follow-up, since an auditor rarely resigns for a neutral reason.
What are the fees, including any expenses passed through to the fund?
Why ask it
Management and performance fees are only the start. Research, technology and even staff salaries charged to the fund can add a great deal, and none of it appears in a headline fee comparison.
How much of your own money is in the fund, and on the same terms as mine?
Why ask it
Co-investment matters less than the terms attached to it. A manager whose personal capital sits in a share class with better liquidity or lower fees is not aligned with you in the way the headline number implies.
What are the liquidity terms, and is there a gate or side pocket provision?
Why ask it
Lock-ups, notice periods and gates decide whether you can leave in exactly the scenario where you will want to. Read the gate language while things are calm, because it is written to be used when they are not.
What happened to your assets and your investor base in your worst year?
Why ask it
Behaviour under stress is more informative than performance under stress. Whether they gated, how they communicated, and whether investors stayed is the best available preview of the next bad year.
How is the investment team paid, and who besides you can stop a trade?
Why ask it
Compensation drives risk-taking, and a single decision-maker with no effective veto is a specific risk you should price. Ask who has actually overruled the manager, and when it last happened.
What do you hold that you could not exit within a week?
Why ask it
This is the liquidity mismatch question, and it is how funds fail rather than merely underperform. Compare the answer with the redemption terms just quoted; investors able to leave faster than the book can be sold is a structural problem.
How do you decide to sell, both when you are right and when you are wrong?
Why ask it
Sell discipline is the least discussed and most revealing part of any process. Ask about both sides, because most managers have a rule for losses and nothing at all for winners.
What is your capacity in this strategy, and at what size do returns start to degrade?
Why ask it
Every strategy has an asset level where the edge decays, and a manager who denies that is selling asset gathering rather than performance. The figure they name is also something you can hold them to in two years.
What is your most uncomfortable position right now, and why do you still hold it?
Why ask it
This moves them out of the pitch and into the present. You learn whether they can hold a thesis under pressure or are quietly talking themselves out of it while you sit there.
How has the book drifted from what the original mandate described?
Why ask it
Drift happens gradually and always for good reasons. Comparing today's holdings against the offering documents is the cheapest diligence available, and their willingness to discuss the gap is itself the finding.
What happens to the fund if something happens to you?
Why ask it
Key-person risk is handled poorly at most smaller funds. Ask what the documents actually say happens on the manager's departure or death, not what they intend to organise at some point.
What do allocators fail to ask you that they should?
Why ask it
A closing question that often produces the most candid minute of the meeting, because it lets them talk about the risk in their own business rather than defending against yours.
Meeting a fund manager
Practical guidance for the conversation itself
Before the meeting
- Read the offering documents and the last two annual reports first, so the meeting is spent on what the documents do not say.
- Write down the two or three answers that would rule the fund out, and ask those questions early rather than saving them for the end.
- Bring the monthly performance series and ask them to walk you through the three worst months.
- Settle your own liquidity needs before you go; terms that look acceptable in a good year are the ones that bind you in a bad one.
Reading the answers
Specific losses beat general humility
Every manager says risk management matters. Only some can name the position that hurt, the size it had reached, and the rule that changed afterwards. Keep pushing until you get the third part.
Watch for process questions answered with performance
When you ask how something is done and get returns in reply, the method is usually weaker than the record. Ask the process question again in different words before you move on.
Separate the strategy from the business
A sound strategy inside a firm gathering assets faster than the strategy can absorb them will disappoint. Fees, capacity and headcount are part of the diligence, not a distraction from the investment case.
Common mistakes on your side of the table
- Asking for a stock idea, which converts a diligence meeting into a pitch and wastes your leverage.
- Anchoring on last year's return, which is the least persistent number any fund produces.
- Accepting a Sharpe ratio without asking about the period, the benchmark, and whether it is gross or net of fees.
- Skipping the operational questions because they are duller than the investment ones, when much of the historical investor loss in this industry has come from the operational side.