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Capital introduction and due diligence

An investor’s playbook


At RSM's seventh annual Investment Industry Summit, a panel of experts spelled out what investors are looking for when they are contemplating an allocation of funds.

"Performance," said Steve Kahn, head of operations at Talpion Fund Management. "There are two piles, one with good relative performance and one with poor relative performance."

The panelists agreed that performance is on the list, but investors have perfected the five minute look, according to Sheryl Mejia, partner at Decagon Advisors. "It has to have a strong fact sheet, expertise, an opportunity and numbers which have to come through on that first look."
The panel was moderated by Alan D. Alzfan, partner and national hedge fund leader at RSM. He asked if there were any turnoffs that should be excluded in the fact sheet.

"Turnoffs are anything that isn't clear or something that appears to be better than it actually is," said Kahn. "Something with a whole bunch of asterisks concerns me."

Once a company is considered there is a significant vetting period along with the initial assessment of a company's due diligence.

The due diligence process

The due diligence and vetting period is significant, according to John Regan, partner and chief investment officer at Permanens Capital. "There are at least two or three meetings with managers before it gets to me."

"Due diligence in the last five to 10 years has really ramped up and the reason is the failure rate," according to Mejia. "You look at the list of top 100 hedge fund firms from 2006—2014. Many of those firms do not exist today."

"When it comes to operational due diligence, the biggest piece of advice I can offer to anyone who manages money is to have certain items in a flowchart," said Kahn. "We are going to ask you about the life cycle of a trade. Have it in a little chart. We love diagrams."

In addition to the life cycle of a trade, including the reconciliations, the other is the cash management process with the approval and reconciliations, according to Kahn. "Get out of your own way. Put it on a flowchart."

Kahn emphasized that the personnel performing the day-to-day trade breaks and reconciliations are key during an onsite review. "You need to be prepared. Be prepared to be judged on your expertise. Know your numbers on a month-to-month basis. Have your processes down cold. It's one thing to lose money from an investment. It's another to lose it from an operational issue."

There are a lot of hot-button issues regarding due diligence according to Mejia. "Everyone wants to see your cybersecurity policy, your expense allocations, changing liquidity conditions and cash controls."

What about emerging funds?

When asked if emerging fund managers were treated any differently than well-established managers during the vetting process, panelists agreed that they are open to hearing from emerging fund managers, as long as they have no conflicts of interest and have the proper processes in place, including hiring well-known vendors.

"We try to keep our investment thesis review and our operational due diligence very consistent but there is a tilt and an early screen of an emerging manager to really dig into their foundational business decisions," said Mejia. "What you're looking for is a manager that in a very short time span can go from a very new thing to a very established well-run business, and if they are ultimately going to achieve a diversified investor base."

Kahn agreed, "I like emerging managers. You're able to go in early and help them fix or implement things that you really want to see and have in place as far as best practices. It just adds to the overall salability."

What is the typical time frame? How long should this process take?

"Years," said Regan. "From a tracking perspective, we track asset classes and we like to know who the smart people are in those asset classes." He added that they may look at someone for years and have no interest but then take another look after they've built relationships and then ultimately make an allocation.

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