Importance of due diligence in post-crisis investing

Dubai: Throughout the credit crisis, investors were shown multiple examples of the unfortunate consequences of failed due diligence. The collapse of large institutions and the outing of multiple fraudulent investment schemes brought to light the relevance and necessity for rigorous due diligence processes.

With confidence slowly returning and global markets appearing to edge forward into more positive territory, investors are looking to return to investing and it is as good a time as any to look at the actual background research that should go into investigating managers and funds before making a decision on where to invest your money.

How can a retail investor carry out due diligence?

Due diligence is the process through which a background check is carried out on a manager, fund or hedge fund's activities, financials and investment decisions.

To perform due diligence means to run a full investigation on the components that result in an investment. It is important that investors remain aware of the possible pitfalls of investing and knowledge about what it is they are putting their money into.

For a retail investor this usually means trusting the institution or bank through which they are buying an investment product and researching the credibility, track record and reputation of that institution. Investors should always do their homework to decide if a product is right for them and if it seems credible.

Not to say that all products need to be looked upon with scepticism, but with more mutual funds in existence than there are actual stocks in some geographies, careful consideration of the best option is a necessity.

It is a fair expectation that the fund manager should be carrying out stringent due diligence on every stock he invests in, and the bank should be carrying out stringent due diligence on that fund manager to make sure that the product is suitable and credible for their clients.

What should a strong due diligence process involve?

Many of the major asset management houses and banks offer a platform of various funds and products via which their end clients invest. That asset management house or bank will often have a team of product selection professionals who are responsible for carrying out the due diligence process before anything is approved for them to sell to clients.

Looking at past performance is a starting point and comparing a manager's returns to those of other managers with similar investment approaches to check for peer group consistency. Proper due diligence will not only look at the top 5 or 10 holdings of the fund, but all the stocks selected by the fund manager and will involve breaking down the performance and volatility across rising and falling markets.

Due diligence in post crisis

Even with financial regulatory bodies stepping up their oversight post-Madoff, there might still be pitfalls in the investment world for an unwary investor. Retail investors might not be able to conduct stringent due diligence into every corner of their investment but by demanding more transparency, and asking questions about liquidity, governance and controls and being wise to the possibilities of those pitfalls they can contribute to pushing the industry towards tighter oversight and higher standards of accountability.

The writer is the CEO of SEI Investments Middle East