Castle Hall has launched the first of three in a series of due diligence ‘primers’ which outline key issues for investors to consider when research managers in a particular asset class or topic area.
The consulting and research firm is a specialist global due diligence consultant, with an Australian and New Zealand office run by Alex Wise, and provider of tools for investors when performing their own due diligence which come under the firm’s ‘Due Diligence University’ banner.
The first primer in the series is for private equity. The next two in the pipeline are on financial statements reviews and hedge fund valuation best practices. The firm says it welcomes suggestions for additional topics for it to address later in the year.
The private equity primer provides a summary of diligence issues across 10 main topic areas, covering the business risk of the manager, the legal risk of the fund and the operational risk of the control environment. It includes a summary of 15 recent SEC enforcement actions and fraud cases in the US which provide real-world examples of how operational deficiencies within the private equity space can impact investors.
Introducing its primer, Castle Hall says: “Private equity due diligence has, over the past two-three years, moved from a rarity to a mainstream process for many institutional investors. However, private equity firms vary widely in their business structure and operational capabilities. Castle Hall has encountered everything from forward looking, best practice organisations to ‘old-school’ firms which respond to due diligence with exactly the same comments as traditional self-administered hedge funds, pre-Madoff.”
“There is a multitude of practises that just, simply, would not fly in other asset classes,” said Alex Wise. “Yet investors have tolerated material operational risks in their private markets investments. Globally, we are seeing increased vigilance that has yet to hit Australia. Our Primer details a slew of SEC enforcement actions in Private Equity, that show why many investors need to wake up to the risks.”
The 10 main topic areas covered in the private equity primer are:
. Management company – such as: ownership, succession, AUM, product complexity, financial viability and staff turnover
- Compliance – such as: regulatory oversight, internal policies, actions or claims against the company
- I.T. – many private equity managers have undeveloped IT systems, disaster recovery plans, cyber-security protection
- The fund – such as: structure, governance and fees, fees often need scrutiny and analysis
- Asset controls – such as: whether the assets actually exist, governance of cash transfers
- Trading controls – including: accounting, allocation of expenses, separation of entities, quality of accounting teams
- Valuation – best practice is for third-party valuations, there should be a valuation committee and backoffice professionals
- Reporting controls – administrators should distribute the investor statements rather than the managers
- Operational DD – have funds of funds done background check on underlying managers, do they outsource operational DD?
- Transparency – private equity managers are more likely to push back on information requests than other managers, many venture managers do not allow investor operational DD.