Performing Due Diligence on Specific Managers and Funds

What this chapter covers

Performing Due Diligence on Specific Managers and Funds: topics in the order to study them

1. 1Due Diligence Process and Framework for Hedge FundsStart here because it gives the map of the whole review: what is checked, in what order, and why both investment and operational work are needed.
2. 2Investment Strategy and Track Record EvaluationNext, learn how to judge what the manager does and whether past results are credible, since this sets up every later risk question.
3. 3Risk Management, Liquidity and Valuation ReviewThis builds on strategy by testing how risk is measured and limited, how liquid the assets are, and how positions are priced.
4. 4Operational Due Diligence and Fraud RiskWith the investment side clear, study controls, service providers and fraud warning signs, which draw heavily on valuation and independence ideas.
5. 5Manager Background, Governance and Fund TermsFinish with people, oversight and legal terms, which tie the earlier findings together and show whether investor interests are protected.

How to prepare Performing Due Diligence on Specific Managers and Funds

1. Read the framework topic first and write a one-page map of the review: strategy, track record, risk, liquidity, valuation, operations, people, governance and terms.
2. For each area, list the questions an allocator would ask and the red flags that would worry you. Keep each list short enough to recall without notes.
3. Practise track record analysis with returns, volatility, drawdown and consistency, and always ask what could make the record misleading, such as short history, survivorship or style drift.
4. Study liquidity by matching asset liquidity to fund terms, including redemption frequency, notice periods, gates and lock-ups. Ask what happens if many investors leave at once.
5. For valuation and operations, focus on independence: who prices positions, who administers the fund, who audits it, and who controls cash movement.
6. Do timed case-style questions on a phone or paper. For each, name the red flag, the risk it creates and the best next action before reading the options.
7. In the last week, review your red-flag lists and the questions you got wrong, and note why the correct option was better than the closest alternative.

Common mistakes in Performing Due Diligence on Specific Managers and Funds

• Treating a strong track record as proof of skill.

  Fix: Always test the record for short history, luck, survivorship, changing fund size, style drift and the risk taken to earn the returns.

• Focusing only on investment merit and skipping operational risk.

  Fix: Remember that a good strategy can still fail through poor controls or fraud. Check operations as seriously as investments.

• Ignoring the mismatch between asset liquidity and fund terms.

  Fix: Compare how fast positions can be sold with how fast investors can redeem. Look for gates, notice periods and lock-ups.

• Accepting manager-provided valuation without asking who checks it.

  Fix: Ask who sets prices, how hard-to-value assets are handled, and whether an independent administrator verifies them.

• Picking an answer that sounds cautious rather than one that addresses the stated red flag.

  Fix: Name the specific risk in the case first, then choose the option that directly reduces or tests that risk.

• Overlooking governance and terms such as side letters and conflicts.

  Fix: Learn how terms affect investors: preferential rights, fee structures and oversight can change your risk even when performance looks fine.

Last-day revision: Performing Due Diligence on Specific Managers and Funds

• ✓Due diligence has two parts: investment review and operational review. Both are needed.
• ✓Check that strategy is clear, repeatable and consistent with what the manager says it does.
• ✓A track record needs context: length, market conditions, size of assets then and now, and consistency of strategy.
• ✓Style drift means the fund moves away from its stated strategy and is a warning sign.
• ✓Judge returns alongside risk, such as volatility and drawdown, not returns alone.
• ✓Match asset liquidity to redemption terms; illiquid assets with frequent redemptions create a run risk.
• ✓Independent valuation is key; manager-controlled pricing of hard-to-value assets is a red flag.
• ✓Independent administrator, auditor and prime broker or custodian reduce fraud risk.
• ✓Weak controls, key-person dependence and unexplained returns are common fraud and failure signals.
• ✓Check the manager's background, references, past conflicts and any regulatory or legal history.
• ✓Governance includes board oversight, conflicts policy and clear fee and side-letter terms.
• ✓Ask whether some investors get better liquidity or transparency terms than others, and what that means for you.

Performing Due Diligence on Specific Managers and Funds practice questions

• During due diligence on a long/short equity manager, the analyst finds that the fund's gross positions can be liquidated, at 20% of average …
• A due diligence analyst is evaluating whether a manager's strong track record reflects skill. Which finding would most strongly raise concer…
• A fund of funds reviews a long/short equity manager. The manager reports an annual return of 9% with volatility of 6%, the risk-free rate is…
• A fund offers quarterly redemptions with 45 days' notice. Its portfolio is 60% liquid assets that can be sold within 5 days, 25% that can be…
• Which practice is most effective for an investor performing operational due diligence to detect potential fraud at a manager?
• An allocator is reviewing a hedge fund manager that has recently reported strong, unusually smooth returns. During operational due diligence…
• Which due diligence practice best mitigates the risk that a hedge fund manager is fabricating trading records or investor statements?
• A fund of hedge funds is conducting operational due diligence on a new manager. Which of the following findings should be regarded as the mo…

Performing Due Diligence on Specific Managers and Funds in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

• CA FinalDue Diligence, Investigation & Forensic Accounting
• CS ProfessionalDue Diligence
• ACCA Strategic ProfessionalSpecific assignments
• CFA Level IIIPrivate Equity