The simple answer to the question:
Why do due diligence on external investment managers?
To ensure that each unit-linked fund managed by an external investment management firm meets its stated investment objectives, abides by its mandate or prospectus and remains broadly within any stated targeted risk range.
Important Role of Financial Brokers
Financial Brokers perform a very important role in understanding the investment objectives and risk appetite of their clients. Based on this understanding, they then recommend a suitable fund or suite of funds from a range offered by a life insurance company or other provider to meet their clients’ needs.
Important Role of Life Insurance Company
The life insurance company also has an important role to play in ensuring that each fund in the range of funds offered under its products continues to meet its stated investment objectives, abides by its mandate or prospectus, and remains broadly within any targeted risk range. Financial brokers depend on life insurance companies to provide this service on their behalf and on behalf of their clients.
One possible way for a life insurance company to achieve this aim is to conduct regular due diligence on its external investment managers.
Frequency of On-going Due Diligence
The frequency of due diligence is likely to be driven by a number of factors. The following list illustrates some of the factors driving the frequency of due diligence:
- A life insurance company may wish to perform on-going due diligence on a newly appointed investment management firm more frequently than on an investment management firm which has a long track record of operation in the life insurance company’s range of funds;
- Strategies with higher risk profiles may require more frequent on-going due diligence; and
- Where issues are identified in on-going due diligence, for example, changes in the investment team or changes in investment objectives, the frequency of due diligence may need to be increased to monitor the implications of the issue.
Type of On-going Due Diligence
Due diligence on investment management firms may take a number of forms including:
- Requesting the investment management firm to complete a questionnaire on a range of risk, return, and operational issues on a monthly, quarterly, or half-yearly basis;
- On-site due diligence visits with an agenda to review specific aspects of an investment management firm’s return, risk management, governance, or operational features;
- Review of commentary on an investment management firm arising from news flow and discussion of the issues in the article with the investment management firm;
- Review of authorisation and publicly available regulatory filings; and
- Review of the audited financial statements and annual reports of the relevant vehicles managed by the investment management firm.
Sample of Issues Monitored as Part of On-going Due Diligence
While the range of issues to be monitored varies with the type of investment strategy, table 1 below illustrates a small sample of topics which might be covered for a fund that does not charge performance fees.