CAIA Level I: An Introduction to Core Topics in Alternative Investments, 2nd Edition

CHAPTER 28

Due Diligence of Fund Managers

This chapter on due diligence is comprehensive and details the time necessary to perform proper due diligence on a fund manager. There is no substitute for time and effort in performing detailed due diligence on a fund manager or 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. While the concept of due diligence covers a wide variety of professional responsibilities, this chapter focuses on performing due diligence in selecting a fund manager.

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 on the fund's structure and various tax, legal, and other characteristics and 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 Kundro1 studied more than 100 hedge fund liquidations over a 20-year period and attributed half of all fund failures to operational risk alone. The International Association of Financial Engineers defines operational risk as “losses caused by problems with people, processes, technology, or external ...