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Hedge Fund Investment Due Diligence Checklist

Hedge Fund Investment Due Diligence Template

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.

What Tasks Does Hedge Fund Investment Due Diligence Include?

Strategy

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.

  • What is the overall strategy of the investment fund?
  • What are the key objectives of the investment fund?
  • How does the fund plan to meet those objectives, in the short and long term?
  • What are the fund’s leverage limits (with respect to the investment vehicle itself) and how heavily is it currently leveraged?
  • What is the fund’s strategy with respect to asset-level debt?

Structure

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.

  • What level of investor approval is required to make changes to the hedge fund’s strategies?
  • Who is responsible for asset-level decisions? What approvals do they require?
  • Who discovers and sources investment opportunities?
  • How are risk management strategies integrated with the activities of the decision-makers?

Fees

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.

  • What are the investment vehicle formation fees anticipated to be?
  • What are the fund management fees?
  • What services are performed in exchange for fund management fees?

Compliance

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.

  • Is the fund facing any current or reasonably foreseeable criminal or civil proceedings of any kind?
  • Was the fund, or any of its principals, ever subject to a legal, regulatory, or civil judgment or negative ruling or order?
  • Are any of the general or limited partners facing any current or reasonably foreseeable criminal or civil proceedings of any kind?
  • Describe the hedge fund’s approach to regulatory and legal compliance. How is it integrated into the firm’s general operations?

Tax

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.

  • What strategies does the fund use to shield taxable clients from taxation on investment gains?
  • What strategies does the fund use to shield investors using tax-exempt accounts from the Unrelated Business Taxable Income provision, or other provisions that attempt to make otherwise non-taxable investment income taxable?
  • Does the fund make use of any novel or unusual taxation structures or strategies that could reasonably be thought to attract the attention of the tax authority?

Miscellaneous Items

Private Placement Memorandum (PPM) Review

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:

  • What are the risks of the portfolio?
  • What is the fund’s derivative strategy and how much exposure does the fund have?
  • What is the average turnover rate for assets owned by the fund? What is your asset churn rate?

Personnel/Biographical Details

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.

  • Are any of the fund’s decision-makers both: inexperienced, and relatively unsupervised?
  • Do any of the fund’s decision-makers have a significant history of either: disreputable employers, or short periods of employment?
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Hedge Fund Investment Due Diligence Checklist

Hedge Fund Investment Due Diligence Template

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.

What Tasks Does Hedge Fund Investment Due Diligence Include?

Strategy

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.

  • What is the overall strategy of the investment fund?
  • What are the key objectives of the investment fund?
  • How does the fund plan to meet those objectives, in the short and long term?
  • What are the fund’s leverage limits (with respect to the investment vehicle itself) and how heavily is it currently leveraged?
  • What is the fund’s strategy with respect to asset-level debt?

Structure

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.

  • What level of investor approval is required to make changes to the hedge fund’s strategies?
  • Who is responsible for asset-level decisions? What approvals do they require?
  • Who discovers and sources investment opportunities?
  • How are risk management strategies integrated with the activities of the decision-makers?

Fees

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.

  • What are the investment vehicle formation fees anticipated to be?
  • What are the fund management fees?
  • What services are performed in exchange for fund management fees?

Compliance

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.

  • Is the fund facing any current or reasonably foreseeable criminal or civil proceedings of any kind?
  • Was the fund, or any of its principals, ever subject to a legal, regulatory, or civil judgment or negative ruling or order?
  • Are any of the general or limited partners facing any current or reasonably foreseeable criminal or civil proceedings of any kind?
  • Describe the hedge fund’s approach to regulatory and legal compliance. How is it integrated into the firm’s general operations?

Tax

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.

  • What strategies does the fund use to shield taxable clients from taxation on investment gains?
  • What strategies does the fund use to shield investors using tax-exempt accounts from the Unrelated Business Taxable Income provision, or other provisions that attempt to make otherwise non-taxable investment income taxable?
  • Does the fund make use of any novel or unusual taxation structures or strategies that could reasonably be thought to attract the attention of the tax authority?

Miscellaneous Items

Private Placement Memorandum (PPM) Review

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:

  • What are the risks of the portfolio?
  • What is the fund’s derivative strategy and how much exposure does the fund have?
  • What is the average turnover rate for assets owned by the fund? What is your asset churn rate?

Personnel/Biographical Details

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.

  • Are any of the fund’s decision-makers both: inexperienced, and relatively unsupervised?
  • Do any of the fund’s decision-makers have a significant history of either: disreputable employers, or short periods of employment?
FAQ

Can I change requests in this checklist or add new?

Every M&A and due diligence process is different. Downloaders are urged to make these checklists their own by changing the providing information to better fit their needs.

Does this questionnaire provide all the necessary due diligence information?

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.

Easily Collect Data Using this Template in DealRoom

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