Due diligence
What is Due diligence?
Due diligence is a structured investigation of an investment, manager, product, counterparty, or service provider before commitment and throughout the relationship.
A diligence record should distinguish evidence supplied by the subject, independently verified evidence, analyst judgment, unresolved questions, conditions, and post-investment monitoring. Versioning matters because a later clean document must not erase what decision-makers knew, assumed, or failed to resolve when capital was committed.
The final memorandum should state who performed each workstream, which primary materials were reviewed, when evidence was obtained, and whose approval accepted each residual risk. Conditions should have owners, deadlines, verification evidence, escalation routes, and a stated consequence if remediation is incomplete or ineffective.
Scope and purpose
Diligence tests whether claims are accurate, risks are understood, terms fit the investor, and controls can support the relationship. Scope should be proportional to size, complexity, liquidity, leverage, jurisdiction, and potential harm. A checklist organizes work but cannot replace skeptical judgment, expertise, and follow-up on contradictions.
Investment diligence
Review strategy, market, edge, people, process, portfolio, valuation, performance, benchmark, risk, liquidity, leverage, capacity, fees, tax, and exit. Reconstruct returns from source data where possible and separate realized from unrealized results. Test downside cases and identify what evidence would invalidate the thesis rather than collecting only confirmatory information.
Operational diligence
Assess legal entities, ownership, governance, compliance, trading, cash controls, valuation, administrators, custodians, auditors, cybersecurity, continuity, insurance, conflicts, and regulatory history. Independently contact service providers where appropriate. Strong investment ideas can still fail through fraud, weak operations, key-person loss, or inability to value, settle, and safeguard assets.
Decision and conditions
Findings should be rated by severity and linked to acceptance, remediation, sizing, side letters, monitoring, or rejection. Unresolved issues and reliance on representations remain explicit. Approval committees need balanced evidence and conflict management. A prestigious sponsor, familiar brand, referral, registration, audit, or prior success is not a substitute for current diligence.
Ongoing monitoring
Update diligence for personnel, ownership, performance, exposure, incidents, service providers, regulation, valuation, cybersecurity, and mandate changes. Set frequency and event triggers based on risk. Verify remediation and retain historical records. Monitoring should detect thesis drift and operational deterioration early enough to act, while recognizing that illiquidity can limit exit after a problem emerges.
Sources and further reading
- Investment Advisers: What You Need to Know, U.S. Securities and Exchange Commission
- Custody of Funds or Securities of Clients by Investment Advisers, U.S. Securities and Exchange Commission