Alternative Investments: CAIA Level I, 3rd Edition

CHAPTER 31 Due Diligence of Fund Managers

There is no substitute for taking the time and effort to perform detailed due diligence on a fund or any other type of investment. Due diligence is the process of performing a review of an investment with an appropriate level of competence, care, and thoroughness. Although the concept of due diligence covers a wide variety of professional responsibilities, this chapter focuses on performing due diligence in selecting a fund manager.

31.1 Due Diligence Evidence and Organization

Due diligence may be viewed as the initial phase of building a relationship with a fund manager. It is a crucial task that investors should do to select a manager. In the case of selecting a fund manager, due diligence aims to identify funds most appropriate for the investor based not only on the fund's structure and various tax, legal, and other characteristics, but also on the manager's strategy, proficiency, risk measurement and control systems, and performance profile (including volatility, return, and correlation with the investor's current or anticipated portfolio and market indices or benchmarks).

Feffer and Kundro studied more than 100 hedge fund liquidations over a 20-year period and attributed half of all fund failures to operational risk.¹ The International Association for Quantitative Finance defines operational risk as “losses caused by problems with people, processes, technology, or external events.”² Feffer and Kundro argue that structural problems ...