Recently, investor demand has increased for private equity, hybrid public / private funds and alternative yield strategies such as direct lending, asset leasing and royalty streams. As such, the more complex nature of these strategies makes both pre- and post-investment due diligence far more important.
Swiss investors, like all investors, have behavioural biases, which can lead to thorough pre-investment due diligence, but a more laissez faire approach to ongoing diligence post-allocation. Given that many of those "fashionable" strategies hold assets which can be hard to value and may have asset existence issues (assets are not held with a custodian or prime broker), that can be a dangerous game to play.
Indeed, in the US, the recent USD1 billion fraud investigation into Platinum Partners, where assets were allegedly inaccurately valued, has focused investor attention on illiquid strategies.
"Swiss investors can sometimes neglect what they can do post-investment" says Christian Nauer, CEO of SwissAnalytics. "To a degree, Swiss allocators can be a little shy in questioning the fund manager once they've made the allocation". SwissAnalytics helps institutions build a risk-based framework to perform operational and investment due diligence. This January, the firm joined forces with Castle Hall Alternatives' global due diligence platform.
"We often notice a self-confirmation bias, whereby the investor agrees to allocate to a manager by focusing at the pre-investment stage on information that supports their initial hypothesis. A risk arises, however, if an investor is slower to act, post-investment, when they are presented with information that no longer supports that initial hypothesis," says Nauer.
For institutions overseeing client assets or pension funds, however, there is increasing recognition that they are responsible for effective due diligence across all external manager relationships, irrespective of asset class. "In the event of a financial loss, it is simply not a plausible defense for an investor to say `oh, that was a private markets fund, so we didn't ask the same questions,'" says Nauer.
"Our advice to investors is, `Establish a clear due diligence program and have a consistent framework and policy to determine how to monitor every third party fund. A well drafted due diligence policy will specify how and when to conduct due diligence and how to escalate issues which could arise on either the investment or operational side.'"
Once invested, an effective ongoing due diligence program will consider frequency, timeliness, completeness, consistency, and objectivity.
"Risk-based approaches are a smart way to define the frequency of ongoing reviews as a function of the risk – be it asset class risk, manager specific risk, or the size of the allocation," he adds.
For SwissAnalytics and Castle Hall, increasing focus on ongoing due diligence has allowed the firms to develop new due diligence solutions.
"External diligence experts can benefit from economies of scale and can pass these on the clients," says Nauer.
"Ongoing diligence also involves a lot of work to contact managers to ask ongoing questions, which can be below the pay grade of the internal investment team. Investors can use external providers to handle the data gathering process – and particularly organise that data and perform quality control checks. This then frees up the internal team to move to an oversight role, where they can review the results and react to questions raised."
