Due Diligence Background Investigations on Hedge Fund Managers

What to Know, Where to Look and What to be Aware Of

When considering a potential hedge fund investment in emerging markets such as Latin America, it is imperative to work with an experienced professional to navigate the often murky waters of due diligence. While this article focuses on hedge fund investing, much of the advice and guidance toward effective due diligence is applicable across multiple business transactions, including M&A and private equity investments, corporate partnerships and other investment vehicles.

September 2012

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As the oldest privately held investigative due diligence firm in the United States, Bishops Services Inc. has seen, in the past few years alone, a substantial increase in our clients' investment volume in developing countries across the globe. Specifically, there has been a significant uptick in hedge fund investing in the BRIC countries (Brazil, Russia, India and China), as well as increased investment activities across other Latin American countries such as Argentina, Chile, Colombia, Ecuador, Mexico, Panama, Peru and Venezuela.

Investing in Latin America brings with it many unique challenges, particularly when investing with local and emerging fund managers as part of an international multimanager investment strategy. These challenges run the gamut from geographic and geopolitical concerns, to the level of transparency in reporting and information retention, to the basic fact that this is an emerging and rapidly developing financial market for the hedge fund platform. Prior to any hedge fund investment in Latin America, we recommend conducting full-scope, comprehensive investigative due diligence (IDD) efforts to complement any operational due diligence (ODD) assessment.

While IDD efforts can be conducted discreetly and without the knowledge of the subject fund managers, when engaging in such efforts in Latin America it is recommended that investigations be conducted as a transparent endeavor. For a multimanager investor, the first litmus test in the IDD process often comes from the fund manager's response to your request that he/she consent to and cooperate with a comprehensive background investigation. Careful consideration should be given to those investment opportunities where a manager is reluctant or refuses to provide such authorization.

Due to the commonality of names, the transient nature of residency, the time constraints surrounding every investigation and investment, and other factors weighing on these types of investigations in Latin America, there are several preliminary factors that can help in facilitating an accurate and expedient IDD process. First, the more information the investor can provide about the fund manager at inception, the more focused and effective the investigation will be from the outset. This would include providing full names of the managers, as well as their biographical statements, relevant information from their prospectus or marketing collateral, address information and any other identifying information that may be deemed helpful in such background investigative efforts. Also critical in achieving comprehensive intelligence is to have an individual's national identification number (similar to a US Social Security Number). Many records in Latin America are recorded only by a name and national identification number; thus this information is critical to ruling out false positives, and honing in on relevant details.

It is important to remember that access to information is not as streamlined in Latin America as it is in the United States. Records may be destroyed during regime changes, are often out of date or incomplete, or may not be made public as a result of political conditions within each country, including an increased susceptibility to external influences within the political, business and financial services sectors. As a result, relying exclusively on commercially available public database information will leave a potential investor with, at the very least, an incomplete understanding of the hedge fund manager, and at worst, an errant or unreliable version of the facts.

Incorporating independent third-party on the ground investigative efforts as part of your IDD process is essential to digging below the surface and having a true understanding of the critical information necessary for making important investment decisions. Working with an IDD partner with access to indigenous resources who are knowledgeable about local laws, customs, conditions and methods of obtaining and recording information, and who know how to accurately research and interpret such intelligence, is a necessary part of any comprehensive IDD effort. These individuals often include former law enforcement and military officials, skilled corporate investigators and researchers, members of local watchdog groups, investigative journalists, and resident business and industry experts.

Successful investigative efforts will vary from country to country in Latin America, and often by region or city within each country. While public record information is more readily available in major cities such as Bogotá, Buenos Aires, Lima, Mexico City, Rio de Janeiro and São Paulo, it is less so in outlying areas. Thus, more creative efforts, including closely held intelligence assets and effective research and analysis is key in rural areas where information is sparsely available and might not be completely reliable.

When investing in Latin America, the decision of whether to investigate the hedge fund entity in addition to the individual fund managers rests on a few simple factors, including the risk threshold of the investor, how long the fund has been in existence, the country and/or region where the fund operates, and the investment strategy of the fund. A seasoned IDD expert can provide guidance on best practices to assist clients in making the determination of whether to include the fund entity into the process on a case-by-case basis. Based on our experience, however, incorporating research of the fund into the IDD process from the outset greatly lessens the possibility that records and information exist that solely name the fund entity and would thus not otherwise be revealed.

When examining a business entity in Latin America it is crucial to look at the ownership records of the fund in order to uncover trends, signs or any red flags of potential concern. For example, we have found that in some Latin American countries there is a higher tendency for business entities to hide ownership or other previous liabilities through a system of false or shell businesses. Similar tactics have been uncovered with respect to obfuscating bankruptcies and other undesirable historical intelligence, which reiterates the importance of incorporating research of the fund into your standard IDD process.

Effective international due diligence hinges upon having a well-versed IDD partner, particularly in places like Latin America where there are so many varying factors influencing the availability and reliability of information. Before you expand your investment spectrum into other countries or regions of the world, be sure that your due diligence process is prepared to handle the cultural and informational nuances that come with it.