Fund Due Diligence – Investor Perspective

1Why fund due diligence matters

• In a close-ended AIF, the investor cannot exit easily, and the investments are not yet known. Choosing the right manager is the main decision.
• Returns differ widely between top and bottom managers, so manager selection adds or loses far more value than in listed markets.
• Due diligence covers investment aspects (team, track record, strategy, process) and operational aspects (governance, valuation, compliance, systems).
• Investors use the PPM, a due diligence questionnaire (DDQ), meetings with the team, data on past funds, and reference calls.

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2The team

• Experience and skills relevant to the strategy: sourcing, investing, value creation, exits.
• Stability and cohesion: how long the team has worked together; turnover of senior people.
• Attribution: which individuals actually led the successful deals in the track record, and are they still here?
• Alignment: the team's own investment in the fund and how carried interest is shared within the team.
• Succession and key person arrangements.

Remember

• People first: experience, stability, attribution, alignment, succession.

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3The track record

• Look at net returns (after fees and carry): IRR, TVPI and DPI for each past fund.
• Compare with peers of the same vintage and strategy, using quartile rankings (top quartile = best 25%).
• Separate realised (exited) from unrealised (still held, valued by the manager) results. A track record that is mostly unrealised is less reliable.
• Check dispersion within the portfolio: were returns driven by one lucky deal or by consistent results?
• Check persistence: has the manager done well across several funds and market cycles?
• Ask whether past results are relevant to the new fund (same team, strategy and fund size).

Example Manager A's last fund shows a 3.0x TVPI, but its DPI is 0.4x and one company makes up 60% of the value. The headline number depends on one unrealised holding: a red flag to examine closely.

Remember

• Net, realised, peer-compared, consistent, relevant.

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4Strategy and investment process

• Edge: why can this manager find, win and improve deals better than others (sector expertise, networks, operating skills)?
• Fit with the market: is there enough opportunity for the strategy and fund size?
• Fund size: a much larger fund than before may push the manager into bigger deals outside its proven skill (strategy drift).
• Process: how deals are sourced, screened, approved (investment committee), monitored and exited, and how risk is controlled.
• Portfolio construction: number of holdings, concentration limits, reserves for follow-on investments.

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5Terms and alignment

• Fees and carry: management fee level and basis; hurdle; carry percentage; catch-up; waterfall (whole-fund versus deal-by-deal); clawback.
• Manager commitment ("skin in the game").
• Key person, no-fault removal and for-cause removal clauses.
• Other fees: transaction or monitoring fees charged to portfolio companies, and whether they are offset against the management fee.
• Expenses charged to the fund, and their caps.

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6Operational due diligence

Many fund problems come from operations, not from investments. Check:

• governance: trustee, investment committee, compliance officer, conflict of interest policy;
• valuation policy and use of an independent valuer;
• service providers: custodian, fund accountant, auditor, legal advisers;
• reporting quality and timeliness;
• regulatory history: SEBI registration, past actions, PPM audit findings;
• controls over cash movements, cyber security and record keeping;
• related-party transactions and how they are disclosed.

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7Red flags

• High turnover of senior team members, or disputes in the team.
• Track record mostly unrealised, or driven by one deal.
• Strategy drift or a big jump in fund size.
• Unusually high fees, or fees that are not clearly disclosed.
• Weak governance, unclear valuation policy, or no independent valuer.
• Undisclosed related-party deals or conflicts.
• Reluctance to share information or allow reference calls.
• Pressure to commit quickly, or promises of returns.

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8The distributor's role

A distributor helping an investor choose an AIF should:

• first check suitability: the investor's wealth, liquidity, time horizon, risk appetite and experience;
• explain the strategy, risks, fees, lock-in and drawdown obligations honestly, using the PPM;
• not overstate past performance or promise returns;
• disclose the distribution fee and the availability of the direct plan;
• document the advice and the investor's understanding.

Remember

• Suitability first; explain risks, fees and lock-in; disclose commission and the direct plan.

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