In Part 1 of the article Five Ideas of CTA Due Diligence, we discussed several foundational concepts to keep in mind when applying a research due diligence process to a Commodity Trading Advisor. At the heart of a due diligence process is to understand as much about the manager as possible.
A couple of years ago I met a journalism professor and I mentioned the students in my graduate level managed futures course at DePaul University write due diligence papers on managers. He said the due diligence process is very similar to how he teaches his investigative journalism students. Until he mentioned it, I never thought about it in those terms, but he was correct, it is the same process as investigative journalism and one can use similar techniques.
During the NIBA due diligence panel I was a part of on September 18, 2013 some of the audience questions included “how can a CTA properly prepare for due diligence meetings?” In this article we discuss due diligence from the CTAs perspective.
Preparation for due diligence meetings is very important for a CTA’s business development. CTAs should understand a due diligence process is often more than one meeting or filling out one document, but is frequently a series of meetings over a period of several months or longer.
Below is a list of foundational ideas CTAs should be aware of for a due diligence process:
1) Properly explain the trading strategy and research process is an obvious task the manager must be able to do. You want the investor or client to feel comfortable in their understanding and expectation of the strategy.
2) During the NIBA due diligence panel discussion we talked about a growing demand from investors for CTAs to have audited track records. A CPA in the audience also confirmed that more of his clients are requesting their track records to be audited.
3) Since 9/11 disaster recovery has become an increasingly important component in due diligence. A plane crashing into a building such as 9/11 is a very extreme case. However, a more likely scenario is if the electricity goes out. Or if the manager has their business in Florida, how prepared are they for a hurricane? Do they have a disaster recovery plan? Where else can they trade from? Where is their data backed up? I’ve found disaster recovery is not often at the top of an emerging manger’s list of priorities.
4) A due diligence process will often include a background check on at least the principals of the firm. This would include where the person claimed to have been previously employed or where they claimed to have gone to school. The background check may also search for past criminal or regulatory issues. Ideally the due diligence process should not find any surprises in the background check.
5) Since Madoff there has been an increase to check for any operational fraudulent red flags. Who are your lawyers and accountants? The focus behind the operational aspects is about how well the manager can run the business.
I frequently receive calls from emerging managers regarding consulting and business development and over time they realize it takes an investment in their firm’s infrastructure and communication of their message to properly build their business.
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Copyright ©2013 Mark Shore. Contact the author for permission for republication at email@example.com Mark Shore has more than 25 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com
Mark Shore is also an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business, where he teaches the only known accredited managed futures course in the country. He is also a Board Member of the Arditti Center for Risk Management at DePaul University.