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Five common mistakes investment advisors make when conducting due diligence on private/alternative investments
With the growing popularity and demand for alternative investments, Investment Advisors increasingly find themselves navigating the complex world of private equity, private real estate, venture capital, and other asset classes that fall outside the traditional scope. While these investments can offer attractive returns and diversification benefits, they also require thorough due diligence to ensure their suitability and safety for clients. Unfortunately, many Advisors often fall short in their due diligence efforts, exposing their clients to unnecessary risks. In this post, we will discuss five common mistakes Advisors make when conducting due diligence on private/alternative investment offerings.
- Lack of expertise in the asset class
One of the biggest challenges Advisors face is a lack of expertise in the specific asset class, which can be due to multiple factors such as a) limited exposure and experience; b) complexity of alternative/private investments; c) time constraints; and/or d) lack of educational resources. Alternative investments often involve complex strategies and require a deep understanding of the underlying assets. It is crucial for RIAs to either develop in-house expertise or seek collaboration with specialists to ensure investments are evaluated thoroughly.
- Inadequate evaluation of the investment manager
When it comes to alternative investments, the quality and experience of the investment manager are critical. Advisors often fail to dig deep enough into the manager's background, track record, and capabilities. Due diligence should involve a comprehensive review of the manager's history, including the performance of past funds, the firm’s ownership, management team stability, and their overall investment philosophy.
- Overreliance on past performance
While past performance can be an indicator of a manager's capabilities, RIAs should not rely solely on historical returns. Past success does not guarantee future results, and RIAs must evaluate the investment based on its present potential and merits. This includes analyzing the market environment, investment strategy, and potential risks to determine if the investment is still suitable for their clients.
- Neglecting operational due diligence
Operational due diligence is a critical aspect of the investment process that is often overlooked by RIAs. This involves evaluating the investment manager's operational infrastructure, including compliance, legal, risk management, and reporting capabilities. By neglecting operational due diligence, RIAs may miss red flags that could impact the investment's overall success and potentially lead to significant loss of capital.
- Insufficient ongoing monitoring
Due diligence should not be a one-time event. RIAs must continuously monitor alternative investments to ensure they remain suitable for their clients. This includes regularly reviewing performance, assessing any changes in the investment strategy or management team, and remaining informed of industry developments. By not dedicating resources to ongoing monitoring, RIAs risk being caught off guard by unforeseen challenges or shifts in the investment landscape.
Conducting thorough due diligence on private and alternative investment offerings is a vital responsibility for RIAs. By avoiding these common mistakes, RIAs can ensure they are providing their clients with well-researched, suitable investment opportunities. A proactive approach to due diligence, coupled with ongoing monitoring, can help RIAs navigate the complex world of alternative investments and better serve their clients.
At Alesco Advisors, we place a significant emphasis on understanding and navigating the intricate world of alternative investments. We leverage strategic partnerships and best-in-class technological platforms to inform our multi-pronged due diligence process, ensuring thorough assessment of investment opportunities. We focus on continuous monitoring and evaluation, thereby managing risks on behalf of clients for whom alternative/private investments are appropriate, while uncovering potential for attractive returns and diversification in this non-traditional investment space.
The content in this blog is provided for informational purposes only, and should not be construed as personalized investment advice.