A strong headline is not a complete due-diligence report

The case and its answers

Every question of this case, with its answer and why each other option is wrong.

A distributor is reviewing Elm Manager for a client who needs transparent reporting and can accept a seven-year holding period. Elm advertises a 24% gross IRR on three selected successful deals. Its complete previous fund has a 15% net IRR, with half the current value in unsold holdings. Two senior investment professionals who worked on the successful deals have left. Elm’s current presentation says that an independent administrator prepares capital-account statements, but no sample statement or service agreement has been supplied. The distributor will receive more commission from Elm than from another suitable fund. No evidence has established that the previous performance was misstated. The concern is incomplete and selective information.

The performance figures and personnel facts are hypothetical.

Do not infer fraud from missing information alone.

1. Q1Which return figure is the better starting point for describing the previous fund’s investor experience?

   • A

     Option A. The complete fund’s 15% net IRR, with its unrealised-value limitation. — Correct answer

   • B

     Option B. The 24% selected-deal gross IRR alone.

     Why it is wrong: It excludes less successful deals and investor-level costs.

   • C

     Option C. The average of 24% and 15%.

     Why it is wrong: The two measures have different coverage and cannot be meaningfully averaged.

   • D

     Option D. A guaranteed 15% return for the new fund.

     Why it is wrong: Historical net IRR does not guarantee a new fund’s result.

   Answer: A. The complete fund’s net figure is closer to investor experience than selected gross deal returns. It still depends partly on unsold valuations and must be described with that limitation. Remember: Compare like-for-like performance and identify unrealised value.

   Hint, shown before you answer in practice mode: Compare the scope and cost treatment of the two figures.

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2. Q2Which follow-up most directly addresses the departure of the two senior professionals?

   • A

     Option A. Check who made past decisions and who will lead the new fund. — Correct answer

   • B

     Option B. Conclude every remaining employee is unsuitable.

     Why it is wrong: The facts do not support that blanket conclusion.

   • C

     Option C. Assume the historical team and current team are identical.

     Why it is wrong: The passage states that two senior professionals have left.

   • D

     Option D. Ignore the departures because the manager’s name is unchanged.

     Why it is wrong: A firm name does not establish continuity of decision makers.

   Answer: A. Attribution and current responsibilities matter. The distributor should understand the departed professionals’ role in past results and assess the people who will make future decisions. Remember: Evaluate continuity of the investment team.

   Hint, shown before you answer in practice mode: Separate the firm’s history from the current team’s capabilities.

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3. Q3How should the administrator claim be tested?

   • A

     Option A. Treat the slide alone as proof of the service scope.

     Why it is wrong: The slide does not verify the agreement or actual process.

   • B

     Option B. Tell the client that the fund has no administrator.

     Why it is wrong: The absence of supplied evidence does not prove absence of a provider.

   • C

     Option C. Assume independent administration guarantees valuations.

     Why it is wrong: An administrator’s involvement does not eliminate valuation risk.

   • D

     Option D. Request evidence of the appointment and review a sample reporting process. — Correct answer

   Answer: D. An appointment document, stated responsibilities and sample report help establish what the administrator actually does. This is more reliable than either accepting the slide unquestioningly or denying the claim without evidence. Remember: Check operational claims against documents and process evidence.

   Hint, shown before you answer in practice mode: Verify the claim without jumping beyond the evidence.

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4. Q4What is the appropriate treatment of the higher commission?

   • A

     Option A. Choose Elm solely because its commission is higher.

     Why it is wrong: Compensation does not establish suitability for the client.

   • B

     Option B. Disclose the relevant conflict and keep the suitability assessment independent. — Correct answer

   • C

     Option C. Reject Elm automatically without examining its merits.

     Why it is wrong: The commission difference requires conflict management, not an unsupported merits conclusion.

   • D

     Option D. Hide the difference because Elm’s past IRR is positive.

     Why it is wrong: A positive historical return does not remove the conflict.

   Answer: B. The payment difference can influence the distributor’s incentives. It should be handled transparently while the selection continues to rest on the client’s needs, risks and the evidence collected. Remember: Manage incentives without substituting them for suitability.

   Hint, shown before you answer in practice mode: The client’s needs remain the decision criterion.

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