A hedge fund collapse and diversification 101: lessons to stakeholders
| DOI | https://doi.org/10.1108/JFC-09-2020-0198 |
| Published date | 06 April 2021 |
| Date | 06 April 2021 |
| Pages | 774-783 |
| Subject Matter | Accounting & finance,Financial risk/company failure,Financial crime |
| Author | Majed R. Muhtaseb |
A hedge fund collapse and
diversification 101: lessons
to stakeholders
Majed R. Muhtaseb
Department of Finance, Real Estate and Law, and CPP Philanthropic Foundation,
California State Polytechnic University, Pomona, California, USA
Abstract
Purpose –The purposeof this paper is events and analysis of present ahedge fund collapse, offer lessons to
investors and hedge fund industry stakeholders and propose a possible remedy for mitigating operational
risks and associatedpotential losses.
Design/methodology/approach –This study focused on one hedge fund case study and conducted a
thoroughinvestigation of the events that led to the collapse and eventual filing of the Securitiesand Exchange
Commission (SEC) complaint.All articles and publications used for this research are available in the public
domain and accessible.
Findings –Wood River Capital Management had concentrated the portfolios of its two hedge funds into one
stock, EndWave Corp. Fund Manager violated terms of offeringmemorandum. Investors were not made aware
of and did not discover the operational risks. Stock price of EndWave plummeted. There was no independent
oversight over the funds. The values of the two funds dropped significantly. Investorsattempted to redeem but
the funds were not liquid. The SEC fileda c omplaint.Mr Whittier was sentenced for three years in jail.
Research limitations/implications –It is an analysis of US-based hedge fund, not an empiricalpaper.
The articlepresents critical analysis and offers many valuable lessons to hedgefund industry stakeholders.
Practical implications –This paper helps investors in terms of identifying a hedge fund’s operational
risks and conducting more effective due diligence while vetting a hedge fund. This could potentially save
investorsand constituents billions of dollars, by avoiding potential hedgefund collapses. This paper suggests
that the scope of fiduciaryduty be expanded to cover hedge fund industry vendors.
Originality/value –Thorough research of a hedge fund that collapsed because of poor investment
decisions, not self-enrichmentat expense of fund investors. This paper provideslessons to investors in terms
of identifying a hedge fund’s critical operationalrisks and conducting value preserving due diligence. This
could potentially save hedge funds investorsbillions of dollars, by avoiding potential hedge fund collapses.
This paperrecommends that the scope of fiduciaryduty be expanded to cover hedge fund industry vendors.
Keywords Fiduciary duty, Fund due diligence, Fund operational risk, Hedge fund collapse
Paper type Research paper
Introduction
Operational risk is an important factor for investorsconsidering making an allocation to an
investment manager especially hedge funds and private equity managers. According to
Basel Committee on BankingSupervision,
“operational risk is defined as the risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events. This definition includes legal risk but
excludes strategic and reputational risk.”
The objective of this paperis twofold:present analysis of a case of a hedge fund collapse and
hence losses to investors owing to failedinternal processes and draw lessons to hedge fund
JFC
28,3
774
Journalof Financial Crime
Vol.28 No. 3, 2021
pp. 774-783
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-09-2020-0198
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