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

40.2 STRATEGY-SPECIFIC DUE DILIGENCE

This section focuses on strategy-specific issues arising in a due diligence process. Rather than being exhaustive, this section concentrates on the major hedge fund strategies and discusses some specific questions related to each of them. Beyond hedge funds, strategy-specific risks should be discussed with all asset managers, whether in traditional investments, private equity, or real assets.

40.2.1 Long/Short Equity

Long/short equity is one of the larger hedge fund categories, both in number of funds and in assets under management. It primarily involves buying equities that are expected to increase in value and selling short equities that are expected to decrease in value.

Essential due diligence questions for a long/short equity fund should include the following:

• What is the exact strategy of the fund? Whenever a strategy could have several substrategies, the investor should seek to understand the precise substrategy that the manager follows. Long/short equity funds now retain a large variety of strategies (e.g., bottom-up stock pickers, equity market timers, long biased concentrated activists, long/short sector specialists, and event driven equities). It is essential to know how the hedge fund can be categorized as well as how its strategy changes over time, if at all. The substrategy followed by the manager will indicate the investment universe that the manager follows. Some long/short equity managers will focus on one sector, country, ...