The average time it takes to select an investment manager is between 3 to 6 months. For some, the process might take over a year or even longer, up to 36 months. Whether an investor is selecting between an established fund manager or a relatively unknown player, the selection process has always been a complex and lengthy process.
On the surface, more time spent on due diligence is considered a good thing. But the question is what is driving the time being spent and can things be more efficient? This is important because if the manager selection process can be shortened, more managers can be reviewed, and thus more investment opportunities can be considered. Also capital can be put to work sooner. The combined effects are better for the end investor as long the due diligence process is not short-changed. Let us examine the factors affecting the process and what steps an investor should take to conduct fund manager due diligence effectively and efficiently.
What are the factors that impact the duration of the fund selection process?
There are multiple factors that affect the duration of the fund manager selection process.
In general, institutional investors fund big-ticket sizes. A ticket size is the amount of money that goes into an investment transaction. In many cases, the larger the ticket size the longer time (>18 months) an investor commits to reviewing a fund. Commitments contribute heavily to an investors decision to increase the duration of the process since the selected manager will most likely remain for an extended period (>3 years).
Another factor is the growing complexity and compliance pressure the industry is facing.
The increasing importance of Socially Responsible Investing (SRI) and Environmental, Social, and Corporate Governance (ESG) combined with the lack of available data in this area had an impact on the duration of the process.
Another factor is the increasing number of available strategies to the investors. The current landscape in the industry has rapidly changed in the past decade or so. The dispersion of new investment instruments, such as Hedge Funds and Private Equity, is so wide and requires skillful and careful manager selection. In addition, due diligence conducted on relatively unknown or emerging players comparatively takes longer than on established ones.
Is the duration of due diligence correlated to the Asset Class?
Some asset classes are considered easier to assess than others such as traditional long-only stocks and bond managers compared to Alternatives. Regardless of asset class, the process will remain relatively long and depends heavily on the expertise to properly evaluate a manager. For example, the expertise necessary to evaluate a U.S. convertible bond arbitrage manager may differ greatly from the expertise needed to evaluate a global macro manager or an Asia-focused equity long/short manager.
Venture capital is seen as one of the most difficult for assessment due to its poor transparency, which is caused by the private nature of the investment transactions and the lack of data produced by the underlying businesses.
Systematic hedge funds are the second most difficult asset class to assess. Hedge fund investors need to go beyond having a deep understanding of instruments, strategies, and markets. A potential hedge fund investor needs to have the qualitative and quantitative investment skills specific to evaluating managers, backgrounds, and teams.
The process is tailored to the strategy being reviewed. Therefore, the factors associated with choosing a hedge fund manager differ extensively from the factors associated with a traditional fund manager.
Alternative strategies, such as Hedge Funds and Private Equity, typically cannot be explained by common factors. Investors may require multiple interactions in gathering a deeper analysis concerning a manager’s skill set. Thus, alternative strategies require multiple interactions and extend the time span.
Which part of the Due Diligence takes the most time?
Perhaps the most time-consuming part of due diligence involves investigating the qualitative review. The qualitative review is an exhaustive process that is critical to the success of the selection. In recent years, the qualitative and Operational Due Diligence (ODD) of managers became critical to the manager selection process.
Investors not only want to learn about the manager’s track record, but they also want to extensively understand the strategy, risk, operation, and key qualitative components.
Traditionally, administrative tasks during the fund selection and oversight process consumes a huge amount of time and squanders human resources. The main issues stem from the multiple back and forth requests that require manual handling of vast amounts of data. Another issue is the length of time it takes to centralize and analyze the collected information.
Data management causes many challenges since teams are handling a huge amount of data collected from multiple sources and in different formats.
How to speed up fund due diligence without compromising the accuracy of the process?
Rushing or taking shortcuts is not a solution since the goal is to ultimately find a manager with the right talent and capability to deal with the selected strategy.
The important question here is not about which tasks to do or not do. Removing or decreasing steps is not the right approach, proper due diligence takes time and great care. The important question here is what steps should be taken to conduct fund manager due diligence more effectively and efficiently?
The most common considerations investors so far have been making to revamp the process are either hiring or outsourcing. Both options reduce the workload on the team, but both come at considerable cost and bypass the key opportunity afforded with specialized technology.
How can technology help conduct fund manager due diligence effectively and efficiently?
Digitizing asset manager due diligence is the key step towards making the process resourceful and accurate. Specialized due diligence technology replaces error-prone and time-consuming manual tasks. Steps can be made to restore order and consequently speed up the process such as digitizing and customizing DDQs, gathering managers´ data in one place, enhancing the flow of communication, and performing analysis and scoring.
However, there is a key overlooked piece when implementing a new automation technology for due diligence. Most investors focus on automating one part of the process, typically the information gathering portion (Due Diligence Questionnaires DDQs). They assume the automation of outreach and digitization of information would be a worthy outcome on its own. The missing piece is what happens after you get the data more quickly and in a digital fashion.
Critical questions to ask are:
- Can all the data be collected in one place, including emails, files, calls, onsite visits, as well as the answers to the DDQs?
- After collection, how is the manager data viewed and shared by the IDD/ODD teams? Can it easily integrate into other internal systems?
- How can manager reviews and risks be efficiently identified and addressed?
- How can the findings be communicated to all the relevant stakeholders?
Only with a holistic specialized solution, investors can improve data traceability and audit trail, enhance internal collaboration and external communication, prevent the risk of human errors, and decrease the risk of missing important information.
These are some of the ways a dedicated and holistic technology can support to speed up the selection process and enhance the quality and accuracy.
Find out more details of technology-based benefits on fund manager due diligence in one of our previous articles talking about how due diligence technology can help fund selectors while working from home.