LO 72.2: Explain elements of the due diligence process used to assess investment

LO 72.2: Explain elements of the due diligence process used to assess investment managers.
Prior to investing, an investor performs due diligence on a potential investment manager, which involves assessing the manager, the fund, and the investment strategy. Information such as the investment background, managers reputation (e.g., education, employers), and past performance have always been key considerations but are insufficient on their own.
An additional element of due diligence involves assessing the investment process and risk controls. The starting point is a review of the funds prospectus or offering memorandum. Additionally, an attribution analysis could be performed to determine how the returns were generated. Were they generated through the skill and control of the manager, luck, and/or factors beyond the managers control? In addition, was the amount of return in line with the amount of risk taken?
Another related element is assessing the funds operations and business model. In general, are there internal controls and policies in place to preserve the investors funds? Specifically, are the controls in place sufficiently robust to detect and prevent fraudulent activities or are limits imposed on managers to seek higher level approval for transactions exceeding a certain dollar amount or frequency? Is there appropriate segregation of duties between the front office and the back office? What is the process and frequency of asset valuations? What is the fee structure and are there any additional fees after a specific threshold? Are there any limitations or blackout periods on redemptions?
In the end, investors should assess potential managers and their investment strategies with an objective and unbiased mind. They should not get caught up with a managers past successes.
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2018 Kaplan, Inc.
Topic 72 Cross Reference to GARP Assigned Reading – Mirabile, Chapter 12
M a n a g e r Ev a l u a t io n

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