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What is Operational Due Diligence?

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  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 14 September 2016
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Operational due diligence is a review of an investment conducted by a third party for the purpose of evaluating risks and helping investors make informed decisions about their investment practices. It is typically employed with alternative investments like hedge funds, as these investments are less subject to regulation. Without regulators to keep an eye on practices, investors need to turn to other methods for monitoring their investments and evaluating potential investment opportunities.

In operational due diligence, an agent of an investor or group of investors thoroughly reviews conditions associated with an investment. The agent examines the structure of the investment's administration, along with practices in terms of accounting and the work environment. This third party can inspect stated assets and liabilities, look into the background of executives, and confirm that the investment is complying with any applicable rules and regulations. Getting a feel for the work environment can also be a part of the work, as tell-tale signs of problems sometimes show up in the form of a hostile or unpleasant office.

This information is used to generate an operational due diligence report. The report also includes a discussion of identified risks and may compare and contrast risks across different kinds of investment products, or leave this up to the investor. The report contains detailed information about how the investment operates and may discuss any concerns the person preparing the report has about the investment, including red flags indicative of problems like fraud.

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An investor can use an operational due diligence report to make decisions about how, when, and where to invest. Reviews of current investments are important for investors who want to confirm that their funds are safe, and who want the unbiased opinion of a third party on investment performance. In terms of prospective investments, thorough research is usually strongly advised so investors can make the best choices for their needs, and avoid needless risks.

Companies offering operational due diligence services can be found in many regions of the world. Varying approaches can be used during the review. Investors may find it helpful to ask for samples and review policies and methods used by several companies before making a decision about which company they want to use for a review of an investment. Other investors may also be able to provide information about the best company for reviews and inspections in their experience, as can publications aimed at investors.

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