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Do your due diligence on alternative investments: AIMA Canada panel

Date: Thursday, May 7, 2009
Author: Megan Harman, Investment Executive

When recommending alternative investments for clients, it is vital to understand the various strategies they emplo.

In the aftermath of the asset-backed commercial paper scandal and the Bernard Madoff scandal, it’s more important than ever for investment advisors to be thoroughly familiar with any product they sell, a panel of investment industry experts said on Wednesday.

Speaking to members of the Alternative Investment Management Association’s Canada chapter in Toronto, the panelists said that the current environment demands that advisors become more stringent in conducting the appropriate due diligence for all investments.

“Make sure that you understand what you’re investing in,” said Mark Purdy, managing director and CIO of Arrow Hedge Partners.

“Don’t be afraid to ask questions,” added Judy Long, director of business conduct compliance at the Investment Industry Regulatory Organization of Canada. She said one of advisors’ most important roles is to determine the suitability of a product for their clients. In order to do so, advisors must have a strong understanding of the product, she pointed out.

“It would be the advisor’s responsibility to take that information on the product due diligence process, understand it, ask questions,” Long added. “It’s your client, it’s your suitability obligation.”

In March, IIROC issued a new set of guidelines on the product due diligence process for investment dealers in response to the widespread problems surrounding ABCP.

When investing in alternative investments in particular, the panelists emphasized the importance of understanding the various strategies.

Don Lefresne, head of alternative investments with RBC Global Private Banking, encourages advisors to educate themselves on alternative investment strategies through books, courses, or colleagues with expertise in the area.

“There’s a lot of information out there,” he said.

When conducting due diligence on a particular fund, Lefresne said business risk is one of the most important factors to consider.

“Is the business a viable business? The manager may able to manage money,” he said, “but there’s a lot of aspects from technology to marketing to risk management, to determine whether it’s a good investment.”

Other important factors to consider include operational risk and the pedigree and skill of the manager, Lefresne added.

As part of the hedge fund manager selection team for Arrow Hedge Partners’ funds of hedge funds, Purdy undertakes especially stringent due diligence measures when assessing fund managers.

“The people are extremely important,” he said. He regularly conducts reference checks on fund managers, including consultations with other fund investors. In addition, he assesses the reputation of the fund sponsor and verifies the fund auditing process directly with the auditors.

Although a strong track record is also important, the panelists warned that solely reviewing the past performance of a fund or fund manager does not provide a sufficient indication of the quality of the fund. Part of the due diligence process also includes assessing the investment environment as a whole as some strategies are far more effective under certain market conditions.

“You have to know what the investment environment is,” said Lefresne.

In the year ahead, alternative investment strategies representing the best opportunities include long-short equity and global macro funds, Purdy said. Lefresne also recommends seeking out higher frequency trading managers and strong bottom-up stock picking managers.