Investing in a hedge fund is obviously a significant and consequential decision for anyone. Trying to manage and understand the complexities of a modern investment vehicle is equally significant. Due diligence is required of any responsible investor seeking to share in the gains (or losses) of the hedge fund of their choosing. Below you’ll find a checklist of the basic questions you’ll need to have answered before entrusting a fund with your money.
Keep in mind that these questions are suited for the preliminary stages of investing in a hedge fund. If you get any answers that are not complete or not to your liking you may wish to follow up and ask further questions. Additionally, the unique structures and strategies of some funds may make different questions appropriate, depending on the circumstances. All investors should use their informed judgment and, if in doubt, consult experienced counsel.
Any inquiries about a hedge fund should begin with the strategy of the fund itself. What investments does the fund make? Why does it make them? Where in the world does it invest?
A strategy is a nebulous topic that encompasses a myriad of other issues. From investment types and locations to attitudes and behaviors regarding leverage, the aim of this part is to gather a birds-eye view of the hedge fund’s structure and goals.
Structure refers to the people making decisions, both behind the scenes and in the front office. It includes both the individuals themselves and the hierarchy and systems in which they operate.
All fees and expenses should be determined up-front. As investment fees can create a significant drag on hedge fund returns, sometimes wiping out the index-adjusted returns of the investment altogether, all fees should be itemized and noted.
A hedge fund is required to comply with a myriad of laws and regulations. How it ensures that its operations are in compliance with legislation should be of utmost concern to the potential investor. Similarly, information regarding the history of the fund itself, and any of its principals, is vital to guarantee the integrity of the investment.
Taxes can cut into investment returns in a big way. Ignore them at your peril. Whether you’re investing with a tax-exempt account or are fully taxable, you’ll want to make sure that the hedge fund is doing everything it can to shield your income from federal and state taxes.
The private placement memorandum (PPM) is similar in many respects to a prospectus. It details the nature of the investments being offered and the risks inherent therein. The exact contents of the PPM will vary depending on what legislation governs the offered securities, but the document should always include information that is useful to the investor. All potential investors should take a close look at the PPM to ensure the hedge fund meets their requirements. Some examples of items to look out for in a PPM include:
The CV’s and brief biographies of all of the firm’s principals and decision-makers should be requested. While the professional histories of the people involved in the fund may be of no moment to you, red flags can appear in the biographies of some people. Limited experience or frequent, short stints with disreputable firms may dissuade you from dealing with a particular hedge fund.
This due diligence questionnaire was created by M&A professionals and includes a comprehensive starting point for the diligence process. Every deal is different, however, and may require additional requests or diligence areas.
This Hedge Fund due diligence template can be easily downloaded and utilized as just the Excel sheet. However, it is most effective when paired with DealRoom’s dynamic due diligence software. We offer a secure space to conveniently request, collect, and house data. Additionally, DealRoom offers analytics, security features, and customized help to streamline the process.