Hedge Fund Analysis: An In-Depth Guide to Evaluating Return Potential and Assessing Risks

Chapter 11

Reference and Background Checks

“Trust but verify.”

Ronald Reagan

“One must verify or expel his doubts, and convert them into the certainty of yes or no.”

Thomas Carlyle

Reference checking is one of the most misunderstood and underutilized aspects of the due diligence process. Reference checks are usually relegated to the very end of the process following dozens and even hundreds of hours of accumulated investment, operational, and risk-related due diligence. This does not make sense from either a psychological or efficiency standpoint. If we were to wait until the end of the due diligence process only to find out that a reference check with a hedge fund manager's former employer raised significant potential issues, we might end up throwing away quite a bit of time, effort, and money. In addition, my experience has taught me that it is human nature to minimize and potentially marginalize smaller issues raised during reference checks after so much effort has already been expended.

The solution is alarmingly simple: Start making reference checks earlier in the due diligence process. I would suggest making a few reference checks after you have conducted your first interview with the hedge fund manager(s) and have determined that you would like to move them through the due diligence process. This is an efficient use of time because making reference checks earlier in the process ...