In a universe of over 10,000 private equity and hedge fund firms, manager selection is complex. It requires analytical tools that help you verify the data, qualitative review and operational due diligence, establishing a network of managers, and ongoing review of your investments. With over 25 years of experience identifying institutional alternative investment managers, below are some of the prudent questions we ask.

Questions About The Firm
1. Who are the partners? What is their background? 
The investment industry is a people business. It is important to understand who owns the firm you are investing in and how active they are in the business. We look for managers who have a proven track record through multiple market cycles.

Understand the institutionality of the firm from technology, trading teams, computer power, disaster recovery plans and the ability to trade in different markets. 

2. How much of the firm’s AUM is partner capital?
We look for managers who invest a significant amount of their own money in their fund, giving them “skin in the game.” If manager compensation is heavily weighted towards performance fees, this will incentivize risk taking. When managers have a substantial portion of their net worth invested in their products, this balances out the incentive to take outsized risks with a desire to preserve capital.  

3. What is the age profile of the firm’s partners? 
Understand where in the life cycle the key decision makers are. If they are nearing the end of their career, understanding the succession plan. Get to know the next generation of the firm’s leaders.

4. When a partner retires, how do remaining partners dilute their equity?
Every firm has a different negotiated process for transitioning ownership. It is important the firm is transparent about it and has a training program for future leaders.

5. What plans are in place for hiring and retaining talent through time?  
Long-term incentive programs must exist within the firm. If the investment talent is not properly incentivized, they will eventually leave to launch a new firm.

Questions About The Fund(s)
1. Who are the service providers?
We like to see independent, top-tier administrators and custodians, the big four auditors and bulge bracket prime brokers and other institutional safeguards.

2. Describe the firms risk management process. How do the investment and risk management teams interact? Do the risk management or investment teams have the power to override each other?
Private equity firms typically manage risk through the control or significant influence they possess over companies in which they invest. Successful PE firms implement strong corporate governance to reduce conflicts of interest between management teams and the owners of the firms.

For hedge funds a dedicated risk management process must exist to provide checks and balances for the investment process. It is important that the risk management team is not compensated in a way that incentivizes risk taking.

3. Is a fund dependent on one individual for its P&L?
Deep teams have a greater ability to identify investing opportunities across sectors, asset classes and regions. Deep teams also reduce the likelihood of key-man risk. However, if a fund is dependent on one individual for its P&L, make sure there is a key-man clause.

4. Do the fund’s asset and liquidity mandates align?
If managers are investing in illiquid strategies, investors need terms that will ensure the manager won’t be forced to sell the portfolio from a position of weakness. Liquidity tools can help you identify if the terms and assets are properly aligned.

5. Compared to its peers, how does a fund pair-up in terms of risk-reward, correlation and liquidity?
Always benchmark a fund to its peers using analytical technology that provides data on how similar funds are behaving.

6. How does a fund attempt to deliver alpha through time?  
Invest with funds that cannot be cheaply replicated by a liquid index. Use tools that measure the alpha coefficient and help you understand the fund’s historical performance and its future potential.

7. What is the demographic of the fund’s investors?
Ideally a fund has a diversified investor base consisting of sophisticated institutions, family offices, high-net-worth investors, and is not too concentrated with any single of group of investors. We work with third-party operational due diligence providers to provide us with insight into a fund’s investors base.

Our investment committee meets quarterly to discuss the results of our rigorous quantitative and qualitative assessments with respect to a prospective fund. We decide if the fund’s performance and metrics are compelling from a quantitative standpoint, if our qualitative research demonstrates the fund is structurally and operationally stable, if the fund’s documents are consistent with their stated terms, and if this all aligns after our onsite visit with the manger. After the initial investment is made, there is an ongoing review. We are always evaluating new funds in the marketplace. 

Steven Brod is the chief executive officer of Crystal Capital Partners.