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Written by:

Arman Salavitabar

Arman Salavitabar

Founding Partner, FundFront

Knowledge

How Fund Managers Can Effectively Prepare for Institutional Due Diligence

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Fund managers seeking to attract institutional investors must be thoroughly prepared for the rigorous due diligence process these investors employ. Institutional due diligence is comprehensive, scrutinizing various aspects of a fund’s operations, strategy, and performance. Being well-prepared can significantly enhance a fund manager’s credibility and appeal. Here’s an in-depth look at how fund managers can effectively prepare for institutional due diligence.

Understanding Institutional Due Diligence for Fund Managers

What is Institutional Due Diligence?

Institutional due diligence is a detailed examination conducted by institutional investors, such as pension funds, endowments, and insurance companies, to assess the viability and reliability of an investment opportunity. This process involves evaluating the fund’s investment strategy, performance, risk management, compliance, and operational infrastructure.

Importance of Institutional Due Diligence

Institutional investors are typically responsible for managing large sums of money and must adhere to stringent fiduciary duties. Therefore, they need to ensure that any investment they make is well-founded, transparent, and aligned with their investment goals and risk tolerance.

Key Areas of Focus in Institutional Due Diligence

Investment Strategy and Performance

Consistency and Clarity: Ensure that the investment strategy is well-defined, consistent, and clearly articulated. This includes outlining the fund’s objectives, target markets, investment philosophy, and decision-making processes.

Track Record: A solid track record of performance is crucial. Provide detailed, verifiable data on past performance, including returns, volatility, and comparison with relevant benchmarks.

Attribution Analysis: Be prepared to explain the sources of past performance, differentiating between skill and market conditions.

Risk Management for Fund Managers

Risk Policies: Detail the fund’s risk management policies and procedures. This includes how risks are identified, measured, monitored, and mitigated.

Stress Testing and Scenario Analysis: Provide evidence of stress testing and scenario analysis to show how the fund would perform under various adverse conditions.

Transparency: Maintain transparency about any risk factors and how they are managed.

Compliance and Regulatory Adherence

Regulatory Compliance: Ensure that the fund complies with all relevant regulations and has a robust compliance framework in place. This includes anti-money laundering (AML) and know-your-customer (KYC) policies.

Documentation: Keep thorough documentation of all compliance-related activities and be prepared to present this during due diligence.

Audit Trails: Provide clear audit trails for all transactions and operations.

Operational Infrastructure

Operational Efficiency: Demonstrate the fund’s operational efficiency, including technology systems, processes, and controls in place to support investment activities.

Service Providers: Detail the third-party service providers involved, such as custodians, auditors, and administrators, and explain how they are integrated into the operational framework.

Business Continuity: Have a robust business continuity plan and disaster recovery procedures to ensure operational resilience.

Team and Governance

Team Expertise: Highlight the experience and expertise of the management team. Provide detailed biographies and track records of key personnel.

Governance Structure: Outline the governance structure of the fund, including the roles and responsibilities of the board of directors, investment committee, and any advisory boards.

Succession Planning: Have a clear succession plan in place to ensure continuity of management.

Steps to Prepare for Institutional Due Diligence

Comprehensive Documentation for Due Diligence

Due Diligence Questionnaire (DDQ): Prepare a comprehensive DDQ covering all aspects of the fund’s operations, strategy, performance, risk management, and compliance.

Supporting Documents: Gather all necessary supporting documents, including financial statements, legal documents, compliance reports, and performance data.

Conducting Mock Due Diligence

Internal Review: Conduct an internal review to identify any potential weaknesses or areas of concern. This can help in addressing issues before they are highlighted by institutional investors.

External Consultants: Consider engaging external consultants to conduct a mock due diligence review and provide feedback.

Effective Communication and Presentation

Clarity and Honesty: Be clear and honest in all communications. Avoid overstating performance or underplaying risks.

Professional Presentation: Ensure all materials are professionally prepared and presented. This includes having well-organized documents, polished presentations, and a clear narrative about the fund.

Building Strong Investor Relations

Ongoing Communication: Maintain ongoing communication with prospective institutional investors. Regular updates on fund performance, strategy changes, and other relevant information can build trust and credibility.

Transparency: Foster a culture of transparency, where investors feel informed and confident in the fund’s operations and strategy.

Common Pitfalls to Avoid During Institutional Due Diligence

Overpromising and Underdelivering

Avoid making unrealistic promises about future performance. Institutional investors are wary of overly optimistic projections and prefer a realistic, grounded approach.

Inadequate Risk Management

Failing to demonstrate robust risk management practices can be a significant red flag for institutional investors. Ensure that all risk management procedures are well-documented and effectively implemented.

Lack of Preparedness

Being unprepared for due diligence can severely damage a fund’s credibility. Ensure that all documentation is up-to-date, accurate, and readily available for review.

Conclusion

Preparing for institutional due diligence is a comprehensive process that requires meticulous attention to detail and a proactive approach. By focusing on investment strategy and performance, risk management, compliance, operational infrastructure, and team expertise, fund managers can present a compelling case to institutional investors. FundFront, with its expertise in the alternative investment space, offers bespoke solutions to help fund managers streamline their operations and enhance their appeal to institutional investors. For those facing challenges in preparing for due diligence, FundFront provides the necessary support and expertise to ensure a successful outcome.

Written by:

Arman Salavitabar

Arman Salavitabar

Founding Partner, FundFront

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