Alternative Due Diligence Basics

From the last OpenAlt conversation, we talked about the importance of Diversification with Alternative Investments. But before you invest in any Alternative Investment, it’s wise to do your due diligence to make sure you are making an informed investment decision every time. In this interview, I talk about the basics of Due Diligence and identify the key areas that you need to take a look at before making an investment.

Hosted by OpenAlt, Chris Carsley - CFA, CAIA, Chief Investment Officer & Managing Partner at Kirkland Capital Group continues the series on alternative investments.

“The two questions you need to ask about the Alternative Investment you're looking at are: "Can this investment maintain its performance through cycles?" and "Can the team manage through up and down cycles?””

- Chris Carsley

“Ask “What is the investment process of the fund manager"?” This is not about what they're actually investing in but more about how do they source the trade?”

- Chris Carsley

Watch the discussion below.

Alternative Due Diligence Basics

Transcript

Rachel: All right, we'll go ahead and get started. Thank you for joining our webinar this morning on Alternative, Investment Due Diligence. We have our host again, Chris Carsley, who's been with us for a few conversations now, who I'll pass it on over to as he dives into this subject.

Chris: Thanks, Rachel. Hello everybody, and thanks for joining us. This is our third, discussion around alternatives. The first one we walked through, what are alternatives? The second one we walked through, what is diversification? A lot of people actually talk about it, but, we dove a little bit deeper. And then we applied the aspect of, how alternatives can be utilized and how they performed historically within diversification.

And this one, as Rachel said, we're gonna be walking through Alternative Investment due diligence. The part that for most people is not very much fun. It's a fair amount of work. And I do want to preface this. This is an introduction to the idea of due diligence. there are a plethora of different types of Alternative investments, and a lot of them have a number of different idiosyncratic measures that need to be reviewed in the due diligence process that you might not find in the others.

I just want to preface that right off the bat, that, so if you guys have specific questions about a particular area that we didn't really dive into, please feel free to, ask those questions. This presentation is also broken into some very specific pieces, and I'm totally okay being interrupted.

Ask a question, type it into chat, raise your hand. and then, Rachel or I will see that and we'll be able to address that question live. But let's dive in because we do have a lot to cover. So let's, next slide, let's look at our base agenda. We're gonna cover, what is due diligence, and then we're gonna break it into its pieces, which I think there's a lot of great books out there.

There's a lot of great resources that you can dive into, and we'll talk about some of those that will cover the investment aspect of due diligence, the operational aspect, and the business aspect of what due diligence is and what's required for Alternative investments. then, we'll dive deeper into parts of due diligence broken into. A number of direct categories that you'll have to focus on, and we'll talk about some of the expertise. If you have a team that performs due diligence, some of the expertise that you might need on that team, or if you are performing due diligence on your own, it'll give you an idea of, the things that you need to be paying attention to, and hopefully you have the time to cover that.

And then lastly, we'll dive into some of the historical red flags. there are a number of things that have come up over the decades in due diligence that have been problems that have repeated themselves. so if you see some of those that come up immediately. It doesn't mean the funds are fraud or something like that.

It's just something you need to be aware of and you need to ask the right questions. and then I'm not gonna ruin it too much in this presentation, but the next steps is part four of this series we're gonna dive into. What are some of those questions that the professionals actually ask to dive in and hunt out those red flags?

So let's go ahead and, dive in. What is, due diligence? simply put, due diligence is the process of performing analysis of an investment. now you can interpret what competence, care and thoroughness might mean. I'm not gonna dive too much into that definition cuz we're gonna cover, a lot of that in the later slides.

But at the base of it, if you're gonna make an Alternative Investment, you have gotta go in. You gotta understand and analyze the investment itself. You gotta understand, what are they trading? And this is where it gets complex and it can go a lot of different ways. Maybe you're looking at a hedge fund, looking at a venture fund.

Maybe you're looking at a real estate fund. Maybe it's debt equity. maybe you're doing a direct investor, you're an angel investor, and you're thinking about various aspects of what I should be considering myself. A due diligence with an individual company. That's where you're gonna get a splintering of this conversation as we dive through and understand the investment itself.

But here's where it gets a little more complex. if none of you on this call have been a securities analyst dealing with public securities, this process is very similar, but most of the information is available for you, in Alternative investments. This information is not usually public, nor is it readily available as you dive in and try to understand the company and the team that's managing the investment.

And that's a process we're definitely gonna cover in the operational, due diligence and business due diligence section. why due diligence? It is painstaking. There's huge amounts of documentation to read through. There's a ton of things that need to be, vetted, and understood so that you understand if something does break, how is it, how is that team gonna manage that problem?

Or what risks you're at as the investor within this investment. I have a statement here that's pretty important. performance alone is not a good indicator of future ability or future ability to generate excess returns. There are some types of investment that have what they call a persistence of return.

that, which means if they had a positive return, they are more likely to have a positive return in future periods. you will find that there's a majority of your Alternative investments, just like your traditional investments, they don't have a consistent persistent, level of return. So you need to really dive in and identify for yourself.

And there again, the particular nature of the Alternative Investment you're looking at to try and find can this investment, maintain through cycles and can the team manage through cycles up and down. and everyone always says one thing, I don't invest based on performance. you're kidding yourself.

Most people do. You're not gonna look at a fund and go, wow, these guys have really performed horribly. Maybe I should write, write a check to them. But we'll talk about some of the. Psychological behavioral finance aspects of looking at performance and how else you need, and what you need to think about above and beyond performance alone when doing an Alternative investments.

Next slide. Alright, here's the three big breakdown pieces. We talked a little bit about, hey, understanding the nature of the investment, the operational and the business side is where you're diving into the team and you're diving into, how the company is built, what have they built, what's their process and procedures.

So let's walk through some of the questions that you can, guide right off the bat is what is the investment objective of the fund? Pretty important. You gotta understand how is this gonna fit into my existing portfolio? Why do I want access to this? How does it behave? So in what markets, and the assets, does this fund manager invest it?

Are they a hedge fund? Are they long, short equity? Are they, an event-driven fund where they're taking, a long, short position in equities or maybe, in relation to an event, or maybe they're structured debt, they're playing senior versus junior debt positions. maybe it's a real estate fund.

What type of equity positions are they taking? what's the structure of how they're putting that together? what is the fund manager's general investment strategy? Now, this is something that, it sounds pretty simple to understand, but you gotta understand how they wrote their documents.

[What, how are they gonna invest your money? They say they're gonna do X, Y, Z, let's just use, a long short hedge fund, for example. And they say they're gonna maintain certain exposures, they're gonna be long, a certain amount, they're gonna be short, and maybe they focus primarily on small cap stocks.

And all of a sudden you're looking at their portfolio and parts of their portfolio. maybe they have a massive concentration or maybe they started going in and shorting large cap stocks. Or maybe they started shorting, ETFs and indexes instead of direct securities that might, they might have an edge in creating alpha or something of that nature.

You need to dive in, understand their strategy and how much they're gonna stick to it and what kind of variance, what kind of style drift can they have if you're reading through a document and they throw the kids in sync at you as their investment strategy. that's probably something, you may be investing in one thing today and tomorrow it's totally different and it may have an adverse effect to your portfolio.

What is the fund’s benchmark? now I come from a background where we've benchmarked everything we needed to understand a relative return based on if I could go get a investible benchmark. I'm not gonna dive too much into benchmarks cuz that's a whole ‘nother three hour discussion. But if I can go in and I can go buy, an ETF or an index that is investible and there's a certain level of correlation, understanding, or best fit, a statistical fit to this strategy, I need to understand, okay, that's maybe a best fit index, that's a best fit investible measure that I can say, is this manager I'm paying fees for this, is this manager creating value above that index net of fees.

So in my mind, And I'm biased cuz this is the way I've always thought about the world cuz I've been benchmarked since I walked out of college and got into investments. You need to think about that. Can you actually come up with a benchmark? Has the fund thought about what their best benchmark to, so another question there.

What is the investment process of the fund manager? This is a step out of what they're actually investing in and more how do they, source the trade? How do you know what's their sourcing capability? What's a little bit getting into, their edge? is it repeatable? one of the things is you might find a number of different strategies that fit a certain time period, and they're very, they make a lot of excess return within a certain time period, but then that trade goes away, spreads, widen and collapse all the time.

So you need to understand, is this one of these trades? Is this something I'm in for the next year? Because it's opportunistic, but it might disappear. And then the fund, will be creating excess returns. that repeatability, of the team to be able to continue and to do what they do is super important assessment of possible failure of execution, of investment strategy,

Okay. What does that really mean? here, this is how they built their team. There's a number of ways to fail, within the, in, investment execution. It could be a trade error, it could be, wrongfully negotiated contract. There's a number of ways you need to understand what's the complexity of how they actually pull their trades off and where mistakes can happen.

If you've got 10 people involved in trying to get, a trade done, there's a lot of potential of your human error. so a number of things to think about with how is this trade executed, how can it break? And what process and procedure does this manager have in place to mitigate that execution risk?

So that's a little bit, we're diving more into a little bit more of the operational business side, and then, lastly, you've got, sorry, this screen blanked up for a second. You've got, what is the nature in the source of any value added by the manager? Now this is directly, that is going right at the edge.

You'll see if you ever listen to me talk, I'll talk about two key factors, even though we've broken it down into three pieces here. I'll usually mention something about inefficiency and edge. What inefficiency is the investment taking advantage of and the edge. does the operational structure and the business structure of the manager and their knowledge base allow them to take advantage of that inefficiency.

So here this is, you're talking about what's their particular edge? What do they have? Do they have an information edge where they are able to obtain information that is not readily available to other investors so they can be ahead of the game? there's a number of investors, both traditional and Alternative, that have that ability.

Is it network? if you're thinking about. One of the most important aspects of a good venture fund is that historical track record and success of those shops really generates a network where they're seeing some of the better deals. They're see they, they're consistently getting quality teams that are coming and running startups.

So they're the ones funding, those best teams and they have the right network. And then that network expands into, not only can the venture company, do something for the fund, can they make introductions to help out with new clients, sales, business development? can that venture fund really help their startup company, move to the next level?

And, some of the best that's their edge is their network. They have all the right phone numbers, and then sometimes it's. maybe you've got something, one of the best, quant managers who might be doing small trades at rapid speed. One of the things that you wanna understand is do they have the right systems in the programming and the coding and the knowledge within the team, to execute consistently on that investment strategy and that their system will allow them to, continue to move forward and deploy that edge.

So those are some of the key aspects you gotta think about with regards to the overlapping circle between investment management and operations. It's everything. You'll find that, I was gonna save this for later, but it's a perfect time to talk about it. In the early days of, the explosion of operational due diligence in '09, cuz everyone realized no one was really doing any operational due diligence before ‘08 occurred.

They were just piling in money and just hunting returns and going after the investment strategy. A number of them realized there was this schism. Who should be doing operational due diligence? Who should be doing investment due diligence and should those teams relate to each other in some way?

And I know this sounds funny now, but at first people were thinking due to, potential Chinese wall issues, those should be totally separate from each other. And I just applied logic and seeing how as I've worked on the operational side and built funds, and I've worked on the investment side as trading and understanding trades, it made a natural fit for me to have them do both at the same time.

And there needs to be an overlap between those teams and an understanding because. In some ways, some investments, you have to understand the operations in the business and how that's actually being, completed effectively. if you just looked at the investment side in isolation, you wouldn't have the full picture.

And if you looked at just the operational side without understanding the nuance of the investment, what it takes to complete it, you also were only looking at, half the puzzle. so in today's world, I think things have become more understood that at some level there needs to be a pretty good overlap between the due diligence of these two sections.

All right, move on to the next slide. And some people I told, man, you might argue with me, and there's, that's an ongoing conversation of you. You know how much that overlap should be and there's all kinds of conflicts of, conflicts that can arise cuz investment teams, they don't really think about the operational risks.

They think about the investment risks, and so they may want to jump into an investment and the operational due diligence people, DK a trade and say, oh no, that, that's not gonna work because these guys don't have even the basic structure set up regardless of the investment action of the team or the potential opportunity and excess return in the investment.

So one thing is now perfect segue into operational due diligence. one key point to walk away with operational risk. is a risk you take in Alternative investments and it's something you're not rewarded for. everyone here probably has heard of the risk reward equation. If I take a certain amount of risk, I want a reward that's commensurate with my risk.

That is not something that translates easily or mathematically when someone is taking an operational risk, it may not transfer to reward. Now the other side of that coin is there are what some people have realized, operational alphas, you can actually have operations in systems or networks in place that actually enhance the return of your investment.

And just like I mentioned earlier, obviously, if I have a startup company within my venture fund and I have the ability to deploy operational network, that's going to increase the return. That wasn't necessarily. obviously it's related to the nature of the, the startup company, but I'm the one that enhanced that return. i.e. Creating an operational alpha for my fund. So something to think about from that standpoint. operational risk, according to the International Association of Quantitative Financing is the loss caused by problems with people, process, and technology and, external events. Looks like we had, some duplicated words there, so apologize for that.

And some of that we've already talked about. if, one of the key, you'll see the note on there, it's estimated that, And this is surprising to most people who haven't read up on this subject. Most Alternative funds don't fail due to the investment. They fail due to some operational failure, a fairly large amount, 50 to 66%.

And it's accounting errors, or it's accounting fraud or some level of embezzlement. It literally had nothing to do with the investment. It was because they did not have process and procedure in place for the protection of, cash movements or, proper monitoring of the mid-office and back office.

So a number of different occurrences have, have happened across all kinds of different funds where the investment people were completely unaware of what was gonna eventually blow up their fund. and it happens, more often than not. with that said, I also wanna let you know that. Operational due diligence and isolation is not this magic tool that finds frauds.

In my years of working for a large fund to fund almost all the frauds we discovered, the process started on the investment side and you said, hey, that's their due. Let's go see if the same matches. And there again, that overlap between investment and operational is what really determined.

Something's not right here, something doesn't make sense. and there you might have a fraud and it's very hard to prove frauds. It takes years. as we all know if we've read the history of a lot of things that occurred post 2008. I say their operational risk, includes middle and back office functions that are directly related to the investment process.

That's a key differential. So you have a number of different processes and systems and people that directly touch. The investment. They are the operations offices that maybe is part of a custodian or they're something within the prime brokerage. they're within financing. Something that has to do with directly related to the investment.

And, so we can move on. I think I've talked enough about operational due diligence. it's a subject that's near and dear to my heart cuz you know, I've built entire teams and certainly recognize the importance of operations within an Alternative, Investment and I think people do focus rightfully so heavily on the investment itself, but at the expense of not really understanding that operational due diligence will tell you how the manager is protecting you as an investor.

What process and procedures have they put in place? What third parties have they put in place? There's just tons of different factors that go into that and we'll dive into some of that later. So what is business due diligence if we just talked about operational? business risk is, the activities in, the business pieces of the business that are indirectly supporting the investment.

So human resources, technology, and it. Office equipment, in physical location. So to give you a couple examples there, in human resources, if they don't have a good program that's doing proper background checks for employees coming in, and they're not vetting, who knows who could be effectively working at the fund that you're about to invest in.

There's been a number of different mentions. I've never run into it personally, but, there's been people who have been exaggerating on their resumes saying that they did certain things or have a knowledge base of something. What is their process of onboarding people?

How strict is it? I know that where I worked, a lot of places it was very hard to be hired. You had to take like tests and walk through example of, Hey, here's a real trade, what would you do? So understanding how they're onboarding and how they're even doing the ongoing monitoring of their employees.

Obviously human resources has become monumentally more important over the last few decades. Not only in the hiring aspect, but the ongoing monitoring and maintenance of the culture. Making sure that there's the right culture and there's no bullying or a variety of other things that certainly can happen in a room full of type A people working at an investment shop.

Let’s just call a spade, a spade. Technology and IT support, this has been just an explosion over the last decade. This is very important to understand who's in charge of this, who's maintaining it, how it's operating. This is just a key aspect to the efficiency of the company. and one, the safety, the other side of it, a lot of part of disaster recovery plans these days are directly related to hacking, the protection of investor information.

So this is a really important aspect of, the business due diligence as it has really become paramount. To, running almost any business these days, especially in the investment management world where investors are demanding more and, there's only so much you can put on the plate and how else are you gonna create efficiencies?

In the old days we could just hire more people. that's not always the answer nowadays. because then maybe the business becomes cost inefficient because you're running a relatively small fund in a capacity constrained trade. you can't just throw people at a problem. office equipment, infrastructure,

Okay. This really requires, and it's interesting cuz not a lot of people doing onsite verification anymore. it's coming back. I've talked to a lot of people who work in due diligence and they are getting back to the routine of now requiring onsite verification and walking through an understanding.

And it goes back to the physical site, is the physical site safe? Is it secure? can people just walk in? I kid you not, back in the day, pre '08, I was going to do a, a review of a hedge fund. I just walked into their office, realized there was no secretary, just walked right in and just went right to the trade desk and sat down in front of an open.

I didn't work for that hedge fund, but I was literally sitting in the heart of their decision making. That's a problem. You shouldn't allow people from outside just walking in off the street randomly, and they can walk right into the heart of your operation. and so what's the physical layout? Is it secure?

When you're there, given the nature of what they need to trade, do they have the right office equipment? Do they have the right systems in place? a lot of people have taken a lot of different steps around cash management and control, dedicated, computers for cash management and wires.

So assess that. Understand if it's a big fund, what are they doing cuz they have the people in the systems and the money and the capability to put these safety protocols in place. What are they doing? So that's an additional assessment. if you're working for a large shop or a family office that's writing big checks, you should take.

The 10 or 15 minutes it takes to assess that and just understand, hey, to the nth degree, how many safety, protocols do they have in place that protects my money and protects themselves as a business. All right, moving on. all This is where we can dive into and I'll totally admit, I give full credit to one of the organizations I work with, the Charter Alternative Investment Association.

They break, due diligence down into these pieces. and I like this breakdown because it goes in, says, okay, great. These are the sections. If I'm gonna sit down and look at an Alternative, Investment, I need to understand fund structure. I need to understand strategy, the administration of the fund. Yes, we need to understand performance and do a performance assessment.

We need to understand portfolio risk. And we'll talk a little bit about that because there's two aspects of, one, how you view risk and how it might pertain to you individually as an investor. But you're also looking at a situation of where, how does the fund view its risks? And that's a very important question.

And having run a number of funds, it's a question I get very rarely, very rarely do people say, what do you think your risks are? How are you mitigating your risks? Or it's what do you, what's gonna break the trade, legal and do your references? there's a number of ways to do references.

I'm not saying one is better than the other. We'll talk a little bit about some of the aspects of references, and then what I'd already talked about earlier a little bit was the comeback of onsite verification. trust but verify. You gotta go see if these people really exist to some extent.

And that's an interesting dynamic, because even for me, I run a small fund and, we have an office, but, a lot of times, maybe that day I'm working from home. things have become very virtual. They've been very, you can run a variety of different company aspects from a lot of different places.

With that said, how are they protecting those mobile laptops, those devices, those connections from being hacked? So let's, jump into fund structure. And this is where I said this is very broken into pieces. So anyone's got any questions at any particular time, jump in. Love to answer anything that you think I haven't covered or something that maybe is particular to, a project you're working at right now.

Obviously one of the first things is legal formation. how is the fund built Now? You've got ss, what are the complexities? what conflicts are in place? There's always conflicts of interest between parties who are running a business and parties i.e. vendors or customers of a business.

It doesn't matter. it's just a matter of how they're identified. Make sure you understand what those are and have a conversation with the manager, of the fund or the company, whichever one you're looking at. Alternative structure. How they're dealing with some of those conflicts. tax impacts are super huge.

There's a number of different investors. I know most of you on the phone might be US-based investors. but what if you're a foreign investor looking at a US fund? I don't want to pay US taxes. What if they built as offshore capabilities to shield me from the US taxes? So there's a number of things to think about there, again, in the structure and the legal formation that helps mitigate and allow investors to come in the way they need to.

Maintenance costs. How much does it cost to just maintain what we've built? Understanding, and this also, I'd like to back up one, one thing also is how much did they pay to build this company? It's one of the things that a lot of people forget to ask. and. A lot of new people to building funds, they go to their lawyer, they pay full freight for a template, maybe a few tweaks and changes, and they just don't know any better that in today's world, the ability to create an alternate investment platform is getting cheaper and cheaper.

And that depends, there's some complexities. I know some people who've got multiple legs to their fund and it still can cost hundreds of thousands of dollars to create. But if you're looking at a relatively simple investment that's US domestic based, you're a US investor, it shouldn't have cost too much to build it.

And so it can give you an indicator of okay, I, did these people really know what they were doing? Did they pay too much? and understand, the complexities ask the question like, oh wow, it cost you $150,000 to build this fund. Walk me through why. , what was it that was unique that costs so much?

Cuz it is getting cheaper and there's tons of lawyers out there that recognize, it, it's a world of templates and, they can actually get a lot done. This is a wheel that's been invented tens of thousands of times. There's not a huge number of changes, proper regulatory structure and.

This is super important. what are their exemptions from, the 40 ACT from SEC filing, have they built their fund correctly from a regulatory standpoint? Do they have their, if it's a Reg D fund, do they have their Reg D in place? When was the last filing?

When was it updated? do they have dedicated legal that actually helped create that? Maybe that's a phone call you make and talk about, maintenance and updating, the filing that this fund might require. if you're unaware, part of due diligence is also a learning process.

I always tell people, yes, it's a lot of work, but you also have the ability to dive in and really understand how people build something that's relatively complex. it's a huge educational aspect to this process. If it's something you wanna learn, how to do geography, where's their home office?

Do they have satellite offices? How are those satellite offices reviewed, controlled, what functionalities happen in home office and what happens in satellites? it's good to understand where are the key people located that are driving the nature of this fund. Are they all in the same place?

Are they geographically, separate from each other? How do they create a, create effective communication to complete the strategy? and as we talked about earlier, the complications of post pandemic. when you're dealing with geography, it's become more complex. You might have, an Alternative Investment opportunity where people might even be in foreign.

And so that's something you should understand. Okay, the people who are, pulling the trigger on something, they're not even within US borders. and maybe you're in Europe and you may have the same issue. It's wait, they're not actually in Europe. we're die in control of it.

He's in Canada, so how does that actually dynamically work out? And what problems can the fund, occur due to time zone differences? And how are they mitigating that? and then onto, personnel. , do your background checks, understand previous jobs? Have they run funds before? How successful were they in those funds?

Whether it's the same strategy or not. I'll be honest with you, there's a lot of smart people out there. And you may have one guy who was off doing long, short and, he takes the base knowledge and then he finds an esoteric trade nature and he's out there doing a trade that's more event driven, like appraisal rights or something of that nature.

It doesn't mean a lot of those skills are not transferable and he's not doing the same thing. And I know a lot of people get hung up on that are you doing the same thing? Exactly. I know a ton of managers who have been very successful at one strategy within their career moved on to another strategy, and they were equally as successful.

Because there is an overlap to the way the, the investment is run or maintained. and then understand the variety of skills within the entity. Do they have the right people to pull off their trade? And I'll give you a perfect example. I walked into, a hedge fund manager outta New York, and they were doing a number of trades, that were event driven, that were based on corporate actions.

And the first question I asked, because I actually did this one, I, worked at a fund was I did event driven trades that were reliant on corporate action officers and making sure you have the borrow of right stock and things like that, that have the right elections. And so I asked the fund, I go, where's your corporate actions officer?

And they actually had one, so that was surprising. and I spent time with him and walked through what he does and how he gets this done. Because in their particular trade that they were working on, it was very important. This person had a network and had the knowledge base of corporate actions so that they could actually go effectively borrow stock.

They could meet their event driven trade, it would've been problematic if they had said they were doing this trade and they didn't have anybody internal with the right skills and network to actually carry out what I thought was the most important aspect of that particular trade. So those are things that you can think about and I know that gets deep, but if you're looking at more and more complex strategies, should understand, how it actually works.

Cuz when it breaks and you're all standing there going, how did it break? you should already know how it should break. and when it does break, you'll understand not only, yeah, I knew they told me that could happen in two, I understand how they're gonna mitigate it. those, that's where you should be positioning yourself post due diligence, not standing flatfooted and just getting a phone call of, oh yeah, we lost a lot of money and you don't know what happened.

And then post 2008, the rise of the service providers, all very important. Probably one of the biggest shifts that we've seen, post 2008 was, the fund administrator, a lot of funds were self-administered. and that, that day was over. or you had a fund administrator that you're fund group owned.

None of that was, compliant anymore and you now needed a third party administrator looking over your shoulder, running performance, being, running accounting, and you're accepting and they're working on perhaps even, valuation aspects as well, depending on the level and the complexity of the administrator.

But does the fund have a third party administrator? And how did the impact, the fund and. Banking, this is, this area is in a schism too because a lot of people historically wanted to work with a big name bank, but they're finding some of the functionality and what they really need from a bank, is cheaper and more accessible, and they have better customer service from smaller banks.

So now you're seeing some major funds or mid-tier funds not using some of the big name, global banks. They're using more super regionals or something, relatively local based on their trade. so recognize that it's all, don't get caught up in like name dropping. Like you pull up a debt for a fund and it's nothing but big names.

That's great, that's fine. But are they getting the best pricing and are they getting the functionality and the customer service they need from their service providers? Because at the end of the day, as an investor, you gotta remember all the expenses for all these service providers. They're your expense.

You're the one eating that cost. because the cost rolls to the fund. So this is where you need to understand, if you're dealing with something where there's a requirement of, collateralized financing or custodial work, you got a prime broker involved in the situation. So understand the prime broker.

What does the Prime broker, facilitate for the fund? Specifically? What are some of the terms that the prime broker offers for the strategy? That's very important to understand because, historically I've seen a number of funds where you gotta have a prime broker, but that prime broker can come down, come back on you, and really you know, squeeze a fund in a way cuz they, didn't have leniency in their terms, for different market events that occurred.

Same with custodians and then legal. there's different kinds of legal, there are big shops that have access. Every type of legal you'd want. So maybe they have access to that kind of legal, if it's a smaller fund. do they have securities law? Do they have corporate law? Do they have, I know a lot of people in the real estate space, they have dedicated legal that specializes in real estate specifically on the foreclosure side.

So identify the various pieces and apply a lot of common sense and logic. Do they have the right people and are those people in a position to look over the shoulder and really make sure these people are doing what they say they do and in the most efficient manner? cuz at the end of the day, you want these service writers not only to service and function the fund, you want them to be there as other parties looking over the shoulder of this fund, hopefully within, with your best interest and then tax knock. This may obviously tax is always going to be, a play in these investments. whether it's either forming 1099's or K-1's, whatever, whatever tends to be put together for the fund. But, the other aspect is are they even audited? Not every fund is audited. It's not a requirement.

But you'll mostly find that, your larger investors or your funds on the way to being what they want to say, institutional quality. That's an open definition. they'll usually have, audit financials. It's another mechanism of someone looking over their shoulder, making sure books and records work with, and understand that audit works with the administrator as well.

It doesn't do any good if audit’s just taking numbers and information from the fund. The fund could be fabricating something. An audit may check into it may not. But the thing is if you combine enough people in the daisy chain that aren't related to the fund, that are securing and verifying and reconciling numbers, you're most institutional type structure, you would see audit, really take information from the administrator, not really from the fund, cuz the administrator should have all that information anyways. and so now you've got two third parties, working together to ensure the fund is doing something right. instead of having the fund materially involved in supplying the information directly that, could be fraudulent.

So I have a stated down there is your house made of straw or brick. That's what this whole section is about. And when you're understanding fund structure is, does the, is the foundation solid? It's my house solid, or is it just, man, it's gonna be really easy to blow over or it's gonna be easy for, things to go wrong.

And that could be a variety of things. Let's jump into the next one is, investment strategy.

Obviously incredibly important. This is where most people spend most of their time. this is what fascinates most people. this is the cool part of due diligence. this is where everybody wants to, be the expert in it. and I'll admit, I even think the same thing, but as I stated earlier, a lot of this investment strategy doesn't work if the rest of it's not built.

I always say, listen, last time I check the top of a pyramid doesn't float magically. You gotta have the middle and the bottom or the top falls and so on. Investment strategy. You're looking at markets, what markets and securities do they trade? We talked a little bit about that. Are they in public markets?

Are they using public market instruments and combining them in a variety of ways? Are they using derivatives? Are they creating their own over-the-counter derivatives? there's a variety of different structures in Alternative investments. and what are they operating in?

What are they trading? What's within the portfolio? And that's also, what we talked about, kind of dives into products. It's okay. Understand the nature and the inherent risks. one of the things is derivatives are not inherently bad. I've used them in almost every career I've ever had in investment management.

It's just understand how they're using it because there is an inherent leverage factor in them. if you're gonna go look at a managed features, how are they structuring and how many dollars are they deploying versus futures contracts? Futures, especially in something like, foreign currency can be massively leveraged.

To an unbelievable extent. you need to understand that, not only, oh, they're using derivatives well, they're using derivatives, and how are they using it? That's the important aspect. They're counterparties. What do they need to make this strategy happen? Like we mentioned earlier that kind of goes a little bit back into some of the service providers.

If I'm running a long short hedge fund, I'm obviously gonna need a prime broker. Who am I using, how do they facilitate, what do I need to get done? And, what are some of the terms, netting effects, cash controls, things like that. but there may be other counterparties. One of the things that a lot of people learned as the world tried to collapse on itself in 2008 was a lot of counterparties were needed for these very esoteric Alternative strategies.

And they didn't realize how many people were involved and how they were all daisy chained together. So when you let one fall, it was a domino effect. All of a sudden, a whole bunch of people suffered. and, I don't think the government quite knew what they were doing when they let Lehman fail, that was the domino that they pushed over and it, it hit other major banks almost immediately.

And so it was this mad race to save the next domino. so yeah, understand the counterparts. What do they really need to have in place to facilitate their trade? trade examples super important and don't fall prey to this. Hey, here's my investment deck and I'm gonna show you all the great trades I made money on.

Anyone who tells you they've never lost money, doing anything ever in investments is either unbelievably rare. we're talking making unicorns look common, or they're full of it. if you like me and you've done a lot of different kinds of trades, definitely had my head handed to me on a couple of them for sure.

But yeah, look at the positive trades. Use those as an example to understand, okay, this is the kind of thing that's in the portfolio, but take the time. what didn't work? What trade didn't work? Or what gave you trouble, within this particular investment? And, why did it break and what did you add to your due diligence process, Mr. Manager? So that maybe that doesn't happen in the future, or is that something that's, maybe could happen again? it's important to understand that. and one of the things we used to do when going in and doing due diligence is I certainly wouldn't let the manager pick the trades he wanted to show me.

I'd be like, no, let's go in and take a look at your book and, I'm gonna pick the trade and we're gonna walk through that. And sometimes I'd pick an old trade, I'd pick trade that didn't work, and if I was lucky enough, I was sitting on the trading desk, I might look at a live trade that was just put in that morning.

And then kinda walk through that entire trade. there again, that depends on your timing and the nature of what type of due diligence you're doing. If you're just an individual investor, you may not have that time or reset resource to afford the cost of doing that level of due diligence. but if you are part of a team, you should be taking that time to walk through some, all kinds of different traits.

Here again, benchmarking. It is very challenging because the nature of Alternative investments is to not be common and easily, understood. Otherwise you'd probably be a traditional instrument traded on some exchange. so it can be very difficult to determine what is a best fit index to understand and benchmark is this manager producing value.

I'll give you examples of when we were benchmarking hedge funds. Often not. You might have, a benchmark that's made up of avoided balance of two or three different components to create a best fit with what they're doing. and sometimes that benchmark would have to change sometimes as often as each quarter.

So that's getting pretty deep and you're getting into kind of like what the professionals are doing. for you, I think one of the easiest ways, if you're just an individual investor, dive in, ask the manager how are they benchmarking themselves? How do they assess that they're adding value?

And understand that process and if it makes sense to you, great. If someone comes in and says, Hey, I'm a debt trader and here's how I beat the S&P 500, you should probably think twice about investing with that person cuz their chosen benchmark is not even remotely related to what they're trading.

So something to be aware of. I know a lot of people. we'll compare themselves. That is just not even a best fit. so you're gonna to press on 'em a little bit if you run into a manager who's doing that. Hopefully you don't. I hope benchmarking has been around long enough and most of the fund managers out there realize, comparing apples and oranges is not the best idea, but.

It still happens. that kind of going back to the trade examples, review current positions in real estate, Hey, what's, let's walk through the properties. It's actually law now for hedge funds on a quarterly lagged quarterly basis, they gotta disclose their positions.

So you can actually pull that up. It should be public. They should have no problem sending that to you. if you're talking to a venture company, one of the things is, they're out there publicizing what they own, trying to build rapport for the company that's within their funds.

So they should have no problem walking through the number of companies that are in their funds. So it should be something that's easily obtainable in a variety of different ways. but be sure you do that, understand what the current portfolio looks like, and then you can ask the next question of what else is next for the portfolio market cycles?

We talked about that a little bit earlier. does this strategy, work in certain. Market cycles and not in others. there's a lot of alternate investments are what they call cyclical. they work in some areas and they don't in others. Identify what those are. Are you in this fund? Are you sizing this, investment correctly at the right time?

And this also gets into and links back to looking at the trades that failed. Maybe those trades that you looked at failed, was it related to a certain time or event? something that was happening, on a global macro basis. so un understand how the strategy structure, works in various market cycles.

Sourcing. How do they source it? Is it repeatable? is it difficult to source? is there a boat around their sourcing? can, is it easy for just anybody to go source this? or do they have a particular niche? what's their current AUM? I know a lot of people think the larger the a u and the better.

But that's not always the answer. What if the fund has a capacity constrained trade? then all of a sudden if you're in a capacity constrained trade and you're managing a billion dollars, eh, you're probably failing somewhere. I'll give you a perfectly good example. I ran into a long short hedge fund manager, out of California, and he was managing around 200 million and he was actually producing alpha on longs and shorts.

I will tell you that is rare. Not everybody does that consistently. And one of his key things is he understood his capacity. He literally knew that, wow, I gotta be able to make money on my shorts. That's my differentiating trade, to why people are investing in me and when I can't do that and it's a size issue, I gotta resize the fund.

And he ran into an issue where he couldn't get proper shorts the way he wanted to, and he returned like a hundred million dollars and said, I'll come back and ask for more money when the market changes, but I can't add value the way I want to due to the capacity constrained nature of what I'm doing.

So he was very proactive in running his a u m. I'm just gonna be honest with you. that was an extremely rare find. that individual and the mentality. Most people who get your money, they'll do almost everything not to return it to you cuz they want to keep the a u m. it's one of the issues now with, people are like, wow, they're large private equity has so much cash sitting on the sidelines, but they continue how is that, what dynamic, what is that gonna create in the future? We don't know yet, but it is concerning when they already have a ton of cash on the side, yet they're continuing to raise. leverage, everyone's I don't want to invest in anything that uses leverage. That's how, you lose your money potentially.

But leverage in itself is and can be extremely useful given the nature of the investment strategy. are they using leverage properly? does the investment only make sense if I deploy a lot of leverage? maybe that's a concern. and that's a better question to ask is, can this put up a return or have the possibility of creating return that meets my requirements, my required return without leverage?

And if they have a little bit of leverage, is to leverage, like in that situation, it would be strategic. So leverage is strategic because the investment really won't work without it. Or is it tactical? is it a tactical deployment of leverage to where they don't really need it, but given the various structure, they can increase efficiencies, in the use of leverage.

Maybe, how venture uses, line of credit or something of that nature, or a small fund is Hey, I want increased capacity utilization of my investor dollars and I got chunky trades. So a little line of credit will allow me to make sure that I'm always deploying my investor dollars at a hundred percent.

So there's, there are aspects of where leverage can be extremely useful. Dive in deeper. Don't just be blind and say leverage is bad. now if you are in a trade that doesn't require leverage and they're massively leveraged approach with caution, it can turn around. everyone's probably heard this saying before.

Leverage is a two-edged sword, strikes cleanly when it's in your favor. It also strikes cleanly right into your face when it's not. so it can be extremely damaging, to your return. And also understand the nature of how they built the fund structure. If they deploy leverage. Can you lose more money than you put in?

You're a limited partner. You should have language in your document that says that's not possible. Just make sure that if leverage blows up and there's a problem, that's going back to the GP, not you. And then last, but certainly not least, is valuation. I've written an entire paper with, one of my good friends, John Canaro.

We believe there's a ton of different issues that people are not assessing and doing proper due diligence on valuation and the core angle, what we're looking for there is how are they valuing the assets, who's valuing it, and how often, always approach with caution. Doesn't mean it's bad or they're doing anything wrong, if they run all their valuations internally and the manager is driving, valuation That can be a problem. cuz you gotta remember, evaluation is important because that's the cost you're getting in for and that's actually the cost you're getting out for. And it's probably the notion of the value of the portfolio of how you're being charged, your management fees. Pretty important to understand how they're thinking about valuation and who runs it and how often it's marked.

And who's double checking it? Do they have a third party, that's actually running valuation outside. So all important aspects. and that, I mean we wrote a 10 page paper on valuation. There again, that's a subject you could go on for hours about, but let's move on. We spent a lot of time, it's very important investments, but administration, we talked a little about that.

Operational efficiencies. It can be a source of, alpha, their systems can, increase return. their processing policies, understand, dive in. Do they actually have a policy procedures manual? listen, it's something you should ask for and you can read through it and understand in the day, in the life of this fund, this is how they deal with everything.

Have they gone through and created SOPs? Do they have standard operating procedures, in place, whether it be middle back office, trading desk. there again, background checks. you need to run your background checks, do your background checks on, the managers, the key people that are decision makers and drivers of the fund.

Also understand and say, Hey, you did your employee checks. Is that something at a high level and there's a number of information they can't share, but what can they share so that you can understand who's working there. staffing and turnover. do they have enough? Do they have enough people to pull off the job they're talking about?

What's been the turnover? obviously if you've got any business that has a lot of turnover, it's a revolving door issue, that's concerning. and especially if you've identified a key person and that person moves on. is there language in the fund structure? They're like, oh wow, the guy who's driving all the alpha, the actual trader left, that's pretty important.

We ran into one example that actually ended up into a series of s e c indictments and everything else was they had this one fund had two funds and they migrated all the investor dollars was in fund day, and all the partners money was in fund B, and all the skilled traders went and worked with fund B.

Obviously that's a real big problem. You basically took all the skillset and moved it over to manage the partner's money. i.e.. the partners of the fund, you were no longer capturing that skillset, for where the investor dollars were. you left. These things happened. It's really crazy. Business continuity disaster recovery plans.

That gets back to your technology. If there's earthquakes, power outages, lack of internet, how do they move? Do they have an offsite in place? How do they make that happen? and then I'm not gonna dive into this, but technology applies to everything above in today's world. So what are they putting in place and how is that working?

And I have a statement down at the bottom there. AUM does not imply institutional quality of operations just cuz he's someone that’s got a lot of money. It doesn't mean they've actually taken the time to reconfigure the operations and the procedures and the policies of the company. So make sure you're, you're assessing that.

Alright, Performance. This is quantitative, you're running the statistics of, your risk measures, your attribution, performance is super important. what I had mentioned earlier is a little bit of that behavioral finance aspect, the herd behavior. and this is up to you. You get to make a choice of how you want to think about this.

Maybe you're diligent enough that you won't be swayed. some people complete all the other due diligence factors first and then look at performance because they don't want to dive in and be wowed by the performance. And now what they have is a bias towards the fund. So everything else you look at through your due diligence process is now biased psychologically, cuz you already like them.

So now you're more bent to cut corners, overlook certain things because you're biased by performance. so that's one of the things that they define as, that herd behavior. That's something you'll have to, do yourself. A lot of bigger teams, they separate the two aspects. they'll merge at a later time, to discuss, how the investment, not so much the performance, how the investment operates, operations and business.

And then they'll dive in and understand have they been successful through all the other three pieces to create positive performance. we've mentioned this earlier, external track records. You can get the manager’s previous businesses they worked at. Were they successful at a previous business and managing money.

AUM volatility goes back to what we were talking about with the capacity issues is how is this fund affected? If a u m grows quickly or do they have the liquidity capability to, take on redemptions? if you have a gap event where people need liquidity, how fast can they give it liquidity, and how will that potentially impact the strategy and the other investors that are staying in the fund?

It was a very big problem for a lot of funds in 2008. they were hurt by other people trying to all crowd through the door too quickly. and frauds. Everyone, everything thinks everyone dives in and thinks due diligence is the effort of finding frauds. Yeah, that may fall out of it, but that really shouldn't be your primary focus.

It should be more of is this something that actually works for what I'm looking for to add to my portfolio? Obviously if a bunch of red flags pop. Yeah, okay. You don't invest. but it is pretty complex to find a fraud. it is not as easy as you may read in the news. it takes a lot of people who have dedicated their life to doing this job of due diligence and even they get food sometimes.

I would just say that it's it, that'll fall out of this process, but it's not a driver. alright, let's move on. portfolio. This is pretty quick. We don't have to spend too much time on this one. You need to understand the internal risks, how does the company perceive their own risk?

That's a great question. Ask that right off the bat. How are they perceiving risk? How are they mitigating and what things have they put in place, to help mitigate that? and how do they monitor it? How do they measure it? And it says something you can get access to on a regular basis. Hey, every quarter you're running this.

Can you send over the risk measures? do they use an external risk company? There's a lot of people who do, that, for some of definitely your mid-tier new, bigger funds, they use external risk companies that come in and run number of measures. I'm not saying that's a positive or negative, it's just another outlet for, potentially more information for you to make your assessment.

How much does this manager understand their own risks? because I always believed it's a risk first mentality. The key to investing is make sure you're not losing money. you obviously want to make money, you want to be rewarded for the risk you're taking, but crawling out of a big negative hole, is literally doubly as hard.

And just trying to avoid it. Counterparty risk. This was one that came to light, over the years. it's a risk, there again, like operational risk, you're not really paid for. one of the perfect examples I have here is I work for a company that had swaps, for people who don't know what swaps are they're a custom agreement for access to, an investment instrument. This one in particular was access to the Lehman Aggregate Bond Index, which is now, I think owned by Bloomberg. and we had a swap for, millions of dollars of access to this. And it's something where, okay, who's monitoring those, who's maintaining that and making sure our exposure is correct.

But regardless of the monitoring with the events that occurred to Lehman it. You were just at a loss. you had millions of dollars exposure to Lehman who was holding your cash, and when they went down, the chance of you getting it was close to zero. and it was very long process to even recoup cents on the dollar

So counterparty is risk, is real. it can happen and you can have a lot of errors that can occur. Lehman isn't the extreme example. but there's a lot of other examples of, where administrators didn't do the right thing or sent money to the wrong place. There is risk there.

Assess what that might be. Or there again, as the manager, what they think it might be. I always love this saying, I can't remember who told me this years ago. When you're assessing risk, you don't get bit by the dog you're watching, you get bit by the dog. You don't. and so that's where you want your head on a swivel as much as possible.

And to understand as much about the risks within an Alternative Investment doesn't mean you're not gonna get bit. It just means the probability of you getting bit goes down. Next slide. legal, as I stated earlier, it was prolific template news. if you read through enough of these PPMs and OA, you'll start to see massive similarities regardless of the investment underneath it.

There are a few aspects of, as you change investment types, this is my own, don't quote me on this. I usually think about 70 to 80% of your legal documents are all the same, and the other 20 to 30% is only differentiated due to the non-standardized aspect of what type of Alternative you're investing in.

So when you're daunted with the idea of, oh, I gotta go read through these PPMs, if you've read a fair amount of 'em, you might be reading a lot of the same language, and you do what I do. I'm hunting for differences. I'm hunting for do they have the core aspects that I want to see as protections and things that should be in a legal doc, but also what have they done differently from other docs I've read?

And so that's one of the things you can identify and then home in and generate due diligence questions out of those differences. I list here the core documents. You're not gonna receive all these from certain funds. Some that are smaller may not have DDQ’s, they may not have compliance manuals.

But you should in most of the funds in the Alternative Investment space, they'll have some form of offering memorandum or PPM or OA describing the base of the investment. they obviously have their marketing deck. You can value that at the level you want to. It is marketing. the DDQ, if you're unaware of what that is, it's a document that lists out how the company views what they've built operationally and structurally. not everybody will have one. your institutional quality ones will definitely have a DDQ, you should request it. if you've got a large organization that has a lot of people, they will definitely have a compliance manual along with, their entire HR process.

And, Procedure. Obviously you want to check entity verifications, is this company in good standing? Is there licensing with the securities, aspects in place If they require s e c filing, obtain proof of that. And then, like I said earlier, policy, procedure manuals, if they have 'em, great walk through, understand how they think their company works and some of their SOPs.

Especially with regards to, risk. one of the things here, I know a lot of people, I've had tons of people say, Hey, I sent all this documentation over to my lawyer. Maybe that person's lawyer is great and their multifaceted and they can understand the dynamics across. The plethora of things that we've covered here, which is a lot, that's a lot to say.

One person's gonna understand everything we just talked about, handing these documents off and walking through and having just one lawyer do it. you need to really assess is that person capable of understanding all the dynamics that you think you need to understand? Some of them might be, but you're asking a lot of your lawyer if you think he's gonna understand every moving piece of, an Alternative Investment and how to assess the level of risks cuz that guy's not writing the check you are.

Make sure you take that due diligence references here. I've had this happen throughout my life. They, they want, current investors in the fund, past investors, why did they leave? sometimes the past investors they can be more difficult to get a hold of.

But here again, if a manager understands how this game is played, hopefully they're ready for that. and then there again, you can also contact, and I did this a lot, was reach out to the service providers, the ones that are real key to the functionality of the fund and the investment.

And there again, there's a set of questions you can ask administrators and a variety of things. And, some you might get answered. obviously, these service writers work for the fund. and it depends on the level of transparency the fund manager has, authorized them to share with you.

Try to get as much as possible, but if you have the chance call them and or, and minimum just, oh, you actually work for these guys, right? Oh, you actually reconcile on a monthly basis, Great. Okay. At least go in and talk to someone at the company that can verify they truly work with the fund.

Trust, but verify always, at whatever level you can. next slide. All right, red flags. and this starts to leak into a little bit of what we'll be talking for next time. red flags, they're the key areas. Like I said earlier, they've generated conflicts and problems in the past and they repeatedly occur.

And I'm not gonna go through all of these, because we'll talk about more of these next time, but I just wanted to, people who want to, collect this deck for later and proves through it. These are some categories, that. , regardless of the type of fund have created issues and some have led to full SEC indictments and, huge fines for the funds.

And some of 'em have literally caused, funds to, close. and like I said, we'll dive into some of these in the next one. So I don't steal all my thunder for, for, section number four. But this is an intro into, and you can see the second one there is valuations.

It is super important to understand how that works. I DK'd a number of investments just on how they run their valuations. it was just too much of an open architecture where the manager just had too much control. and I just, and they didn't want to take on a third party valuation, so I was like fine, Have a nice day.

You just don't need my money. Don't be afraid to say no. this due diligence process, you gotta come forward with what works for you and the whole objective, I know this sounds negative, but you're trying to get to the "No" quickly, you wanna spend as little time getting to the "No" as humanly possible.

And if everything keeps on clicking forward, then, okay, it's a yes. And that, and, getting to a yes can take a long but getting to a no, you want it to happen very quickly. and some of these things that we'll talk about on the red flags, the things that you can dive in pretty quickly.

All right, next slide is next steps. one of the things that people always ask is great, Chris, you've now bored me to death for the last hour talking about due diligence. What other resources can I possibly use to go and further educate myself? like I said earlier, I work a lot with the CAIA. It's a nonprofit organization that's simply focused on research, networking and education and alternatives. another great resources is the ILPA.com it's a website to where, it's literally an entire website built on education, a variety of different templates and ideas and discussions around LPs.

You're going to make an investment in an Alternative Investment, you are in my definition, an LP. And they have created what is an ever growing resource. and they talk a lot about rules, regulations, give you ideas, continue to develop your network. Identify. Maybe you're an expert in, venture, hey, I want to think about real estate.

Okay, you might have a great venture network, but you should probably start building a network in, the real estate area for further education and also potential, access to deals. There's a number of different networks out there that can be a great start. and then lastly is, if you have the money and the capability, maybe you're a small family office, maybe you're getting started, maybe you're someone who's Hey, we've always been doing x.

Like I said, you, maybe you're a family office of the specialized in venture and startups and you want to add real estate to your portfolio. how to think about due diligence. And one of the things that I've seen a lot of companies who have, the size and monetary capability, there are services available, for access to data, research, and actual people who will perform due diligence.

You can be like, Hey go out and look at this particular fund and tell me what you see and send me over the report. There are a number of different companies out there that perform that service that's not, I know, very functional for the individual investor, because these services can cost a lot of money, but it's something to realize that they are available.

And sometimes a lot of those services you can go to Cambridge Associates and they have a lot of information that is just generally available for people who are wanting to go in and educate themselves. same with Preqin and obviously I think one here in Seattle with me is, PitchBook, if it's something you're really focused on, startups in the private equity world, another, great, resource. And alright,

We already talked about what we're gonna be covering cuz we're gonna be going through some of the questions on some of those red flags. and diving into, if I am gonna go tear somebody apart, what myself and many of my other colleagues that work professionally in due diligence, what do we actually ask?

And we're gonna walk through and give you actual questions that we go through to and start betting. I look forward to that. it'll be another one that, hopefully we can get done in, a timely fashion because as you can imagine, this is a big investment space.

It is. there's a lot of ways to go with this. so I hope I covered, a number of subjects that, are useful, created at least some areas of thought. And, if you have any questions, fire at will..

Rachel: Yes Thank you everyone. Please type any questions that you have into the chat box so we can help answer those for you. One that we had come in, Chris, is if I did not do due diligence on my investment, is it too late?

Chris: No, it's not. If you were writing a check into something, it's always good to go back. you might be in an investment that's got a liquidity issue where you know you can't get out for a certain number of years or maybe there's a lock period. That's fine.

But it's not too late. You take a number of things that we've gone through and looked at and, you can go back and ask these questions and start filling in your file. start building this good habit of Hey, before I do this. and I know there's sometimes a lot of pressure to invest fast.

Hopefully that doesn't happen too often cuz investing quickly without doing your research, doesn't always end up being a poor decision. But it can't, it increases the probability of it for sure.

Rachel: Okay. another one is, is due diligence ongoing? Meaning should I do this on an annual basis?

Chris: yes. that's a great question because that is literally how one of the greatest frauds that everyone knows about got away with a number of things. Yeah, Madoff and a lot of others were allowed to exist for an extremely long time because a number of investors, didn't continue to push with ongoing monitoring of the investment.

I truly believe this, that no one wakes up and says, Hey, not no one, there's always someone, but majority of people who are gonna go in and do in the investment business in the alternatives, they truly do have a belief in the product they're creating. And they definitely start the day off right?

And they truly are trying to do best for investors. Sometimes things can go wrong, they don't take correct actions. and then down the road, There can be some fraudulent activity, and if you don't have ongoing monitoring of, or a set process that's gonna be able to catch that it's gonna be a problem.

Now, I will say this, if you have someone really super smart trying to defraud you a hundred percent of the time and you're spending 20% of the time trying to catch 'em, even if you have ongoing monitoring it can be tough. And that's where in today's world, that those third party service providers hopefully have process and procedure in place that can help you with that ongoing monitoring and detect things that might go wrong over time.

Rachel: Okay. Let me see. It looks like someone raised their hand here.

Chris: Oh, yeah. We can definitely send a recording out and share the deck. I saw, yep. I did have, I had one question actually that, the person was not gonna be able to join and they sent me this question. they were asking about checklists. This is, it's a plague of the early days of doing due diligence is I walk in and I sit down with a manager and I have my checklist. Do you have a fund administrator? Yes. Check. do you have your prime broker or, do you have cash controls in place where it's dual cash control check?

And all they're doing is really spending about 35 minutes in a conference room. checking boxes, checklists are very helpful to make sure you are not missing something you think is important, because as you can tell, there's a lot to cover and when you get into the heat of it, you can forget things. So that is where a checklist is very important to have a checklist as a primary proof of I've done my due diligence will get you in trouble because. If I ask, do you have a fund administrator? Yes. Great. You check the box. Do you now understand by the nature of that question and checking that box, how that fund administrator integrates with the fund and is properly assessing middle and back office functions, or running valuations or reconciling bank account?

You don't understand any of that. You didn't ask that question, and that's really not on the checklist. you gotta go in and verify and ask that next level of question so you can take it off the checklist and into a level of, true understanding of, how the fund is built and how it operates.

So I'm not, saying negative things about checklist, but don't think that's the end of the questioning. , you've gotta have another level that really dives a next level and says, Hey, how is this all working together? and there's tons of different checklists out there.

I think the ILPA actually has, provides a couple different checklists for you to start with. So if you don't have a checklist already, you can certainly use this deck and come up with a number of different questions and a variety of other things to hit. but there are other people out there, and I will tell you this, checklists are a little different depending on the Alternative Investment.

Obviously there's some things that I'm gonna ask on the venture side that I may not ask on the hedge fund side and vice versa.

Rachel: And then it looks like we had someone raise their hand. so I'm going to unmute. Let's see. Hi Dulce, did you have a question for us?.

Chris: I think in chat she actually, she was just asking can we send,

Rachel: Oh, is it the same one? Okay.

Chris: Yeah, I think so.

Rachel: Okay, cool.

Chris: So yeah, the answer of that is yes .

Rachel: Okay. Awesome. thank you everyone for joining. Chris and I are always available, so any follow-up questions, please let us know. There's a contact us, that'll be directed towards Chris as well.Again, if you have any follow up questions and we will be sending the recording, which is also available on our website. So thank you for your time today and we're excited for the next webinar. Thank you, Chris.

Chris: Thank you everybody.