In the increasingly complex world of alternative investments, due diligence serves as a cornerstone for making informed and prudent investment decisions. Proper due diligence not only unravels the nuances of a fund’s operating model and strategy but also ensures compliance with the investor’s risk appetite and investment goals. This section outlines the key components of conducting due diligence specifically geared towards alternative investment strategies.
Manager Evaluation
The evaluation of fund managers forms the bedrock of due diligence in alternative investments. This assessment involves several critical aspects:
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Background Verification:
- Verify the manager’s credentials, experience, and professional history.
- Assess their track record in the management of alternative investments, specifically focusing on past performance and consistency of returns.
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Competence and Strategy:
- Understanding the manager’s investment style, strategies they’ve employed previously, and their adaptability to market changes.
- Analyzing their strategic execution, ensuring they possess a coherent and actionable plan that aligns with investor goals.
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Track Record and Performance Consistency:
- Evaluate historical performance metrics, while taking into account market conditions during those periods.
- Emphasize the importance of risk-adjusted returns rather than focusing solely on gross returns.
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Alignment of Interests:
- Ensure that fund managers have an incentive structure that aligns their interests with that of the investors. This typically involves scrutinizing their investment in the fund alongside their mechanisms for profit-sharing.
Operational Risks
Operational risks encompass those risks arising from the people, systems, and processes essential to the functioning of an alternative investment fund. Proper evaluation in this sense comprises:
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Systems and Technology:
- Assess the robustness and reliability of the fund’s information, transaction, and monitoring systems.
- Examine the IT infrastructure for potential vulnerabilities and the systems in place to handle data breaches or cyber threats.
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Controls and Governance:
- Inspect the internal control framework, ensuring there is adequate segregation of duties and checks and balances within the organization.
- Scrutinize governance structures, including the composition and functionality of committees like the investment and risk committees.
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Process Evaluation:
- Document and review processes for core activities like asset valuation, risk management, transaction processing, and reporting.
- Look for any red flags in methods for liquidity management, fund accounting, and transparency of operations.
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Business Continuity and Compliance:
- Evaluate operational resilience, emphasizing the fund’s ability to continue functioning efficiently under adverse conditions.
- Ensure compliance with relevant regulations and standards, alongside established internal compliance measures.
Conclusion
Conducting due diligence in alternative investment strategies is a multifaceted endeavor requiring meticulous scrutiny of managerial competence and operational robustness. A robust due diligence framework not only minimizes risks but also ensures that the selected strategies align with overall investment objectives. This process ultimately empowers investors and institutions to make informed decisions in the dynamic alternative investment landscape.
Glossary
- Risk-Adjusted Returns: A measure of return that takes into account the risk taken to achieve it. Commonly used ratios for measuring risk-adjusted returns include the Sharpe Ratio and the Treynor Ratio.
- Operational Risks: Risks that arise from inadequate or failed internal processes, people, and systems, or external events that can disrupt the operations of an organization.
- Alignment of Interests: A situation where the personal and financial interests of fund managers align with those of the investors, ensuring both parties benefit mutually.
Additional Resources
Summary
Chapter 21, section 21.3.1 of the Canadian Securities textbook emphasizes the significance of conducting detailed due diligence when engaging in alternative investment strategies. By thoroughly assessing managers and operational frameworks, investors can better align with their investment objectives and mitigate inherent risks. This careful examination ensures financially sound and strategic investment decisions.