The thought of curtailing the on-site visit causes a great deal of consternation amongst due diligence professionals the world over, many of whom insist that on-site checks remain vital in digging out disingenuous and even fraudulent actors in the fund industry.
Without the ability to go on-site – perhaps for some time into 2021 – important questions have to be addressed. For example, what due diligence can be done effectively without going on-site? Is what can be done sufficient to facilitate the allocation of capital? What are investors missing if they (or their consultants) don’t go on-site, particularly for operational due diligence?
The changes in work practices brought about by COVID-19 show no signs of abating. Many large companies will accelerate working from home options in the long term. In terms of due diligence, we have learned to adapt to conducting diligence remotely. Technological improvements in video conferencing and secure online transmission of information have facilitated that.
At the outset, it’s worth noting that most institutional level due diligence is conducted under a Non-Disclosure Agreement (NDA) as well as via an online data room controlled by the fund manager or implemented by the investor’s operational due diligence consultant.
Additional transparency had already created significant efficiency well before COVID-19 as investors and consultants were able to access documents (questionnaires, financial statements, marketing materials, policy documents etc.) ahead of time and focus on the insights gleaned.
Following the virtual release of documents, some investors began to adopt the model of a pre-visit conference call to discuss the findings from the documents viewed off-site. Again, the need for lengthy on-site visits – starting at Page 1, Question 1 “what is the name of the management company?” – was being curtailed. From the manager’s perspective, the disruption of investors camping out in the office for days was being reduced – something that allowed important staff to spend time on their day jobs.
There became no need for the important initial Q&A to happen in the manager’s office. At Castle Hall, we have found there to be additional benefits to the Q&A off-site, in that more interested parties can dial-in from multiple locations and that investors and consultants can take time to confer on issues offline or via chat.
For many international managers, an array of regulatory filings is available online, for example with the Securities and Exchange Commission in the United States. SEC filings are a treasure trove of information and contrast greatly in volume compared to the line or two of information available from the Australian Securities and Investments Commission website. The media is also a vast and accessible source of information when accessed through a professional public record search platform, while Google searches tend to be problematic because of the algorithmic bias towards paid or popular content.
Therefore, off-site diligence can be robust. A thorough review of public materials and those provided by the manager, combined with a detailed conference call can elicit a strong data set capable of analysis from a seasoned diligence professional.
Investors then have to assess the key elements of a due diligence review that still need to be fulfilled. This might include inspecting the Manager’s brick and mortar office, their personnel, systems and the most secretive of all documents – that’s right – the compliance manual.
Look them in the eye
One area that requires deeper consideration is the effectiveness of in-person meetings and the shaking of hands and in other in-person communications as tools for engendering trust.
Half of Manhattan and most of Geneva looked Bernie Madoff squarely in the eye and decided to trust him. It took the FBI five years of undercover informants and wiretaps to produce evidence of Tom Petters’ wrongdoing. However, a review of the data beforehand should have produced enough red flags to at least slowdown allocations until answers could be uncovered. This may have been the case, but these fraudulent managers were able to talk their way out of red flags in person. This was certainly the case with Madoff and his multiple feeder funds.
However, the cultural importance of the in-person meeting cannot be underestimated, it has been a bellwether of trustworthiness for centuries. In addition to building social relationships, personal interactions also provide fuel to that often-underrated decision-making engine – the gut.
Investors will need to decide whether or not to proceed with new allocations regardless of the possibility of no on-sites this year, or in the event of a major global second wave, next year. Simply stopping all allocations until the world normalises is a remedy that might cause other fiduciary issues as opportunities are missed.
Looking forward, off-site, desk-based due diligence – performed thoroughly – allows consistent and systematic data gathering and analysis. Perhaps investors need to reassess their off-site processes and bolster their ongoing use of consistent data sets as part of the due diligence.