Investment decisions are based on facts and figures known and understood at the time. Due diligence is a process of verification and communication to provide a reasonable basis for an investment decision.
Its main parameters are the frequency and depth of review, and this most often depends on the type of investment. Good due diligence provides an investor with actionable information before they invest and is updated regularly.
Successful investment is based on well-reasoned analysis; excessive risk taking is inherently speculative and, in absence of sound operational practices, can eventually lead to a total loss of capital. And despite the rise of technology, in person meetings remain crucial to understanding logical process.
Due diligence effectively separates luck from skill and confirms a repeatable process. This can be very tough to achieve. Identifying managers with the ability and temperament to be a capital allocator is key. One of the best starting points is incentives. We verify compensation structure to make sure success is shared, and key people stick around. Otherwise, high turnover is the result.
Investors should know when to walk away from overly complex or excessively levered strategies. Leverage and illiquidity combined can be deadly. One should only invest in an enterprise that is completely understood.
We begin our due diligence with a thorough understanding of the investment strategy, the fund and management structure that support it, and make sure that that the whole investment team have significant incentive for investment success.
Quantitative analysis can confirm those managers who have demonstrated good consistency and asymmetry of returns. Managers are often unaware of performance presentation standards and best practices. Disclosure is the number one problem in our investment due diligence work.
Comparing mandates properly requires a very clear understanding of the underlying strategies and investments. With this it should be reasonably straightforward to establish accurate peer groups of managers by mandate, securities traded and other criteria. These can be compared with established benchmarks to see if active management is actually worth paying for. In private debt and equity, we look for how capital has been allocated compared with the investment model. The next question is how the manager achieved these results.
The qualitative assessment is much more difficult and tends to come from experience that is sometimes hard won. Intuition is crucial. Every company’s marketing pitch sounds good, but the main point is whether their investment philosophy or logical process is sensible in their chosen field.
Does the manager process information in a superior way? A clearly defined investment universe addressed by a cohesive long-standing team tends to be able to achieve better results.
We are very wary of over-confidence. Therefore, we believe proper due diligence links manager incentives with an understandable mandate, demonstrated results and a good team, supported by sound operational best practice.