Hedge Fund Data Collection: 13F Filings and Beyond (Part 2)
In Part 1 we looked at what a Due Diligence Questionnaire (DDQ) is and how Travers uses it to collect initial data on a hedge fund. In this second part, we cover the rest of the DDQ, the other materials you should request, how to analyze performance data, and one of the most useful free tools out there: SEC 13F filings.
The Operational Side of the DDQ
The DDQ is not just about investment strategy and performance. A big chunk of it covers the boring but critical operational stuff. Here’s the thing, this is where a lot of fraud and blowups actually happen. Not in bad stock picks, but in weak operations.
Travers walks through several operational sections in the DDQ for Fictional Capital Management (FCM):
Fund Directors - Who sits on the board? How independent are they? FCM has three principals (portfolio manager, research director, COO) plus three non-affiliated board members who each get $15,000 per year in fees. They meet quarterly by phone and annually in person. One thing Travers notes: the directors have never disagreed with any firm decision. That could be a good sign, or it could mean they are not really doing their job.
Fund Administration - Who calculates the NAV? How often? For FCM, the administrator handles NAV monthly and has been with the fund since inception. The COO and CFO visit the administrator one to two times per year. That is a good sign of oversight.
Valuation - This is a critical area. You want to know: who prices the assets, and how independent is that process? FCM keeps things simple. All holdings are level I assets (exchange-traded), so pricing is straightforward. The administrator handles all pricing, and the fund manager never provides instrument prices. Zero percent of assets are in non-exchange-traded instruments. Clean and easy to verify.
Prime Broker - Assets are held in the fund’s name (good), but not segregated from the prime broker’s assets (common, but worth noting). FCM uses a single prime broker but plans to add a second one within six months.
Custodian and Auditor - Standard stuff, but you still need to confirm who they are, how long they have been in place, and whether ongoing due diligence is being performed.
Data Overview: Follow the Money
The DDQ also asks for hard numbers on fund assets. FCM reports $275 million in net assets. The investor base breaks down like this:
- Fund of Funds: 60%
- Foundation/Endowment: 22%
- High Net Worth: 9%
- Pension: 5%
- Internal Investment: 4%
The top three investors hold 24% of the fund (12%, 8%, and 4% respectively). That concentration is something to watch. If any of those big investors pull out, it could create a liquidity crunch.
Fund capacity is set at $500 million. How did they determine that? The team previously managed $750 million at their prior firm (GCH Advisors), so they feel $500 million is well within what they can handle. They plan to soft close the fund for a year once they reach that level to reassess.
The biggest historical redemption was $11 million in December 2008 (12% of NAV at the time), because a fund-of-funds client needed liquidity. Given that this was during the financial crisis, that is actually not bad.
Investment Strategy Section
This section of the DDQ tells you what the fund actually does with the money. FCM is an equity long/short fund, primarily U.S. focused. Key parameters:
- Net exposure range: -30% to +75% (average 46% since inception)
- Max long position: 10%
- Max short position: 6%
- Instruments: 95% equity, 5% options
- Liquidity: 75% of portfolio can be liquidated within 5 trading days, 100% within 30 days
Their edge, according to them: they find companies that are “under the radar screen” and not widely held by other hedge funds. They focus on small and mid-cap stocks with strong management, positive cash flow, and growth prospects. For shorts, they look for overleveraged companies or those trading way above their true value.
One interesting detail: they invest in “nonconsensus names,” meaning stocks that other hedge funds do not hold. This creates genuinely different return patterns from their peers.
Other Materials: Beyond the DDQ
Travers makes a strong point here. Do not stop at the DDQ. Always ask for:
The fund’s presentation - gives you a more visual, streamlined view of the operation. Compare it to the DDQ. The information should be consistent. If the story differs between documents, that is a red flag.
Monthly or quarterly letters - this is where Travers gets really enthusiastic. He calls these letters “worth their weight in gold.” Why? Because they show you what the manager was thinking in real time, without the benefit of hindsight.
Here’s the thing about monthly letters. A manager can tell you in a meeting how calm and methodical they were during 2008. But the monthly letters from that period might tell a different story. Maybe exposures were flipping around constantly. Maybe the tone was panicked. Or maybe the letters confirm exactly what the manager claims. Either way, you get truth on paper.
If the fund lists their top holdings in these letters, Travers suggests you do your own homework:
- Research those companies yourself
- Track their real-time performance
- Calculate performance attribution
- Compare the group to an appropriate benchmark
This is what separates a good analyst from a lazy one. Do not just take what they give you. Get your hands dirty.
Further Analysis: Picking the Right Benchmark
After reading all the materials, Travers realized something. The S&P 500 was not the right benchmark for FCM. The fund invests in small and mid-cap stocks, so the Russell 2000 is a much better comparison. He also uses the HFRI Equity Hedge Index as a peer group benchmark.
The analysis revealed several interesting things:
Low correlation - FCM’s correlation to the indexes ranged from 0.35 to 0.42. That is actually very low and supports their claim of investing in nonconsensus names.
Strong downside protection - The up/down capture ratios tell the story:
- Versus Russell 2000: captured 15.2% of upside, only 13.8% of downside
- Versus HFRI Equity Hedge: captured 62.2% of upside, only 24.6% of downside
In plain English, they do not make as much when the market goes up, but they lose a lot less when it goes down. Over time, this matters because of negative compounding. Losing less in bad times is often more valuable than gaining more in good times.
Exposure management - Looking at historical exposures showed that FCM did a great job reducing risk in 2008 and putting it back on in late 2008, earlier than many peers. But their 2009-2010 returns were somewhat light despite increased exposure.
Pro forma analysis - Travers introduces a simple but powerful calculation. Multiply the fund’s average net exposure by the index return for each month, then compare the result to the fund’s actual return. The formula looks like this:
Pro Forma Return (July) = Russell 2000 July Return x FCM’s Average Net Exposure
Where Average Net Exposure = (June month-end net + July month-end net) / 2
FCM’s actual returns looked much better than all three pro forma return streams. This implies the fund’s stock selection was actually adding value, not just riding market beta.
13F Analysis: Free Intelligence from the SEC
This is one of my favorite parts. The SEC requires hedge funds managing over $100 million in 13F securities to report their long positions quarterly. These reports are free and publicly available.
For equity-focused hedge funds, Travers pulls the latest 13F and builds a basic report that includes:
- Sector and industry breakdown
- Selected valuation and growth ratios
- Recent performance metrics
- Market capitalization data
- Average trading volume
- Recent stock performance
But here’s the problem with 13F filings: they only show long positions, they are delayed by 45 days, and they do not include shorts. So you get a partial picture at best. Still, it is a free partial picture that gives you real data to work with.
The real value of 13F analysis is preparation. If you research a few of their holdings before your first call with the fund manager, you can ask much better questions. You can discuss specific companies with actual knowledge instead of just nodding along as the manager talks.
Travers notes that hedge fund managers act differently when they realize you actually know something about their portfolio. That extra effort on your part changes the dynamic of the conversation.
The Hedge Fund Journal: Write Everything Down
Travers keeps a journal for every fund he reviews. Nothing fancy. Just notes, thoughts, comments, and questions that come up as he reads through the materials. He used to use paper notepads but switched to an iPad app for better organization and searchability.
The key idea is simple: as you go through DDQs, presentations, monthly letters, 13F filings, and performance data, write down everything that strikes you. Questions you want answered. Things that do not add up. Observations about the manager’s style or consistency. This journal becomes your roadmap for the initial call or meeting with the fund manager.
Key Takeaways
Chapter 4 Part 2 teaches us several important lessons:
Operational due diligence matters as much as investment analysis. Fund directors, administrators, prime brokers, and auditors are all critical infrastructure. Weak links here can lead to fraud or blowups.
Pick the right benchmark. Using the S&P 500 for a small-cap long/short fund would lead to wrong conclusions. Match the benchmark to the strategy.
Monthly letters are gold. They show you real-time thinking without hindsight bias. Read them carefully, especially from crisis periods.
Use 13F filings. They are free, public, and give you real data to prepare for conversations with fund managers.
Do your own homework. Research holdings, calculate attribution, compare to benchmarks. The more you know going in, the better your questions will be.
Next up, Travers moves to the initial interview, where all this preparation pays off.
Previous: Chapter 4: Data Collection (Part 1) Next: Chapter 5: Initial Interview (Part 1)