CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

CHAPTER 11

Monitoring Private Equity Fund Investments

Investors in private equity (PE) funds may assume that little can be done, besides divesting on the secondary market, to prevent problems once the due diligence process has been completed and the commitment to the fund has been made; however, ongoing monitoring throughout the life of a private equity investment is a necessary control mechanism. In such a long-term business, initial due diligence findings quickly become obsolete, while changes to the economic environment can fundamentally alter the balance between investor and fund manager interests. The information asymmetry and moral hazard–related problems associated with such changes can be lessened through monitoring.

11.1 APPROACH TO MONITORING

Monitoring involves the routine and systematic collection of information. In 1997, Robbie, Wright, and Chiplin noted that private equity limited partners typically engage in few monitoring actions. The authors expected this trend to continue, as a more proactive approach often raises questions about cost-effectiveness.

11.1.1 Monitoring as Part of a Control System

Monitoring involves more than simply the issuance of warnings. Instead, it should be seen as part of a larger control system within the investment process (see Exhibit 11.1). Its role is to observe, verify, and control in an attempt to make the portfolio perform in a desired way.

EXHIBIT 11.1 Control System

The monitoring process involves identifying problems and developing ...