Operational Drag is a term used in the hedge fund community to refer the negative effects of operational risk on a hedge fund. The term was first used by author Jason Scharfman in his book Hedge Fund Operational Due Diligence Understanding the Risks (Wiley Finance 2008).

<h3> <u>Formal definition:</u> </h3>
Operational Drag is defined as the negative effects of operational risk on the efficiency of an organization. This concept can be analogized to the theory of drag in aviation.

<h3> <u>Diagnosis procedure:</u> </h3>
The amount of Operational Drag present in a hedge fund is often diagnosed by hedge fund investors via a process known as operational due diligence.

<h3> <u>Correlation with operational risk:</u> </h3>
Operational Drag is positively correlated with the operational risk present in a hedge fund. The higher the operational riskiness of an organization, the higher the Operational Drag.
By lowering the Operational Drag throughout the organization, a hedge fund can increase its operating efficiency and subsequently lower its total operational risk.
It should be noted that the positive correlation between operational risk and Operational Drag is not necessarily linear in nature.

<h3> <u>Correlation with expected return:</u> </h3>
There is generally a negative correlation between the expected return a hedge fund will yield and the amount of Operational Drag present in a hedge fund.

<h3> <u>Calculation processes:</u> </h3>
There is no one agreed upon methodology for the calculation of Operational Drag.

<u>References:</u>
http://www.riskglossary.com/link/operational_risk.htm
[http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470372346.html Hedge Fund Operational Due Diligence: Understanding the Risks by Jason Scharfman (Wiley Finance 2008)]
Corgentum Consulting operational risk page