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Unit study guide · NISM Series XIX-A

Fund Due Diligence – Investor Perspective

23 questions in this unit

What this unit covers

Key ideas

From the practice bank · 1

What is the main purpose of fund due diligence before an investor makes a commitment?

Fund due diligence assesses the fund, manager, governing terms and material risks before commitment. It supports an informed decision but cannot guarantee an outcome. Remember: Due diligence is evidence-based assessment rather than a guarantee.

Hint Think about what evidence an investor needs before agreeing to long-term obligations. Common mistake: Reducing fund selection to the highest displayed return.

XIX-A-082

From the practice bank · 2

What should be established before attributing a previous fund’s track record to a manager’s current investment team?

The investor should establish the current team’s actual role in the earlier investments. A firm-level history cannot automatically be attributed to every person now employed by the firm. Remember: Track-record attribution requires evidence of responsibility.

Hint Connect the historical investments to the people who actually worked on them. Common mistake: Assuming that every current employee created every past investment result.

XIX-A-083

From the practice bank · 3

What does a key-person provision in a fund agreement typically address?

A key-person provision addresses agreed consequences when specified important professionals become unavailable. Possible restrictions and replacement procedures depend on the contract. Remember: Check what the agreement does if a crucial team member leaves.

Hint Consider what happens when the people central to the strategy can no longer perform their roles. Common mistake: Assuming that naming a key person ensures that person will never depart.

XIX-A-084

From the practice bank · 4

Why is a fund’s vintage year relevant when choosing a private capital performance benchmark?

Vintage year helps identify funds that began under more comparable market conditions. Strategy, geography, fees and maturity still matter when selecting a benchmark. Remember: A useful benchmark should reflect both the strategy and the investment period.

Hint Compare the market environment in which funds began deploying capital. Common mistake: Comparing funds from very different market cycles without adjustment.

XIX-A-085

From the practice bank · 5

What makes a reference check more useful when assessing an investment manager?

References are more useful when relevant people describe firsthand experience that can be probed and compared. A reference’s relationship and possible bias should also be considered. Remember: Prefer specific, checkable experience over promotional praise.

Hint Consider whether the reference can support its opinion with observed events. Common mistake: Treating a carefully selected testimonial as a complete reference check.

XIX-A-086

From the practice bank · 6

Which review belongs most directly to operational due diligence on a fund manager?

Operational due diligence examines controls such as cash handling, records and oversight of service providers. Strong investment ideas do not compensate for weak operations. Remember: Manager assessment includes the operating system behind investment decisions.

Hint Look beyond investment ideas to how the organisation handles assets and information. Common mistake: Reviewing investment performance while ignoring cash and record controls.

XIX-A-087

From the practice bank · 7

One fund advertises gross internal rate of return and another reports net investor return. What is needed for a meaningful comparison?

The returns must be reconciled to a consistent cash-flow and fee basis before comparison. Their measurement dates and valuation assumptions also need to be compatible. Remember: Comparable return labels need comparable calculation inputs.

Hint Check whether both percentages describe the same level of investor experience. Common mistake: Ranking different performance measures as though their percentages were interchangeable.

XIX-A-088

From the practice bank · 8

Why does a track record dominated by unsold holdings need particular scrutiny?

A track record dominated by unsold assets depends heavily on valuation assumptions. Those estimates need scrutiny because eventual sale prices and timing may differ. Remember: Understand how much performance is realised and how much is estimated.

Hint Separate completed cash outcomes from estimated remaining values. Common mistake: Giving an unsold valuation the same certainty as a completed cash exit.

XIX-A-089

From the practice bank · 9

Why might departures of experienced deal leaders weaken reliance on a manager’s historical record?

Past performance may be less relevant when the people responsible for it are no longer managing the fund. The remaining team’s capability and continuity should be assessed. Remember: A track record must be read together with team continuity.

Hint Link the skills needed for future execution to the team that remains. Common mistake: Assuming that a management company’s historical record survives every team change unchanged.

XIX-A-090

From the practice bank · 10

Beyond the amount, why should an investor examine how the sponsor finances its commitment?

The financing terms can change the sponsor’s economic exposure and incentives even when the stated amount is unchanged. The structure should therefore be understood rather than assessed only by its headline number. Remember: Alignment depends on economic exposure as well as the stated commitment.

Hint Look at who ultimately bears gains and losses on the commitment. Common mistake: Treating the commitment percentage as a complete measure of alignment.

XIX-A-091

From the practice bank · 11

Why should a much larger successor fund be tested against the manager’s established investment strategy?

A larger fund may need larger deals or more opportunities than the previous strategy supported. The investor should assess strategy capacity rather than assume size is an improvement. Remember: Fund growth should be consistent with the strategy’s capacity.

Hint Consider whether the original strategy can absorb the additional money. Common mistake: Assuming that raising more capital necessarily improves the investor proposition.

XIX-A-092

From the practice bank · 12

Why should due diligence examine a key manager’s outside business interests?

Outside interests may create time pressures or conflicts with the fund’s responsibilities. Their nature, disclosure and management matter more than simply counting them. Remember: Assess whether outside activities affect the manager’s ability to serve the fund.

Hint Consider attention, incentives and competing obligations. Common mistake: Ignoring other commitments because the manager has a strong reputation.

XIX-A-093

From the practice bank · 13

A ₹2 crore management fee is reduced by 50% of ₹0.6 crore transaction fees under the contract. What management fee remains before tax?

The management fee remaining is ₹1.7 crore under the stated contractual offset. Offset = 50% × ₹0.6 crore = ₹0.3 crore. Remaining fee = ₹2 crore − ₹0.3 crore = ₹1.7 crore. Remember: Apply a fee offset to the correct base and in the correct direction.

Hint Identify the amount to which the offset percentage applies. Common mistake: Assuming that an offset percentage applies to the management fee itself.

XIX-A-094

From the practice bank · 14

On a ₹1 crore fee base, Plan A charges 1% plus ₹40,000 yearly. Plan B charges 1.2% only. What is their annual difference before tax?

Plan A costs ₹20,000 more on the stated base. Plan A = 1% × ₹1 crore + ₹40,000 = ₹1,40,000. Plan B = 1.2% × ₹1 crore = ₹1,20,000. Difference = ₹20,000. Remember: A lower fee percentage can still produce a higher total charge.

Hint Convert both fee arrangements into rupees before comparing them. Common mistake: Comparing percentages while ignoring fixed costs.

XIX-A-095

From the practice bank · 15

Capital calls of ₹18 lakh and ₹22 lakh fall before any receipts. Available cash is ₹25 lakh. What funding shortfall must be addressed?

The funding shortfall is ₹15 lakh because total calls exceed available cash. Calls = ₹18 lakh + ₹22 lakh = ₹40 lakh. Shortfall = ₹40 lakh − ₹25 lakh = ₹15 lakh. Remember: planning must include all relevant commitments, not just the next call.

Hint Aggregate the obligations falling before the next cash inflow. Common mistake: Assessing each capital call separately against the same available cash.

XIX-A-096

From the practice bank · 16

A fund’s private placement memorandum limits investments to healthcare businesses. A sales presentation describes planned property-development deals that do not fit that limit. No approved strategy amendment is available. What should due diligence establish before commitment?

The investor should resolve the mandate inconsistency through the authorised documents and amendment process. Marketing material cannot silently expand the fund’s investment authority. Remember: A sales claim must be consistent with the authorised investment mandate.

Hint Compare the proposed activity with the authority actually granted to the manager. Common mistake: Allowing an attractive new opportunity to override the agreed strategy without proper process.

XIX-A-097

From the practice bank · 17

A mature private credit fund reports a lower net return than a young venture capital fund. The venture figure depends mainly on unsold company valuations, and the funds have different risk and timing profiles. How should an investor interpret the ranking?

The return figures alone do not provide a like-for-like comparison of manager skill. Appropriate strategy and vintage benchmarks, cash-flow details and valuation evidence are needed. Remember: Normalising fees is only one part of a meaningful benchmark comparison.

Hint Examine strategy, maturity and valuation basis before drawing a conclusion about skill. Common mistake: Attributing differences in strategy returns entirely to manager skill.

XIX-A-098

From the practice bank · 18

A wealthy investor can fund all expected calls without borrowing. However, the investor says that even a small temporary loss would cause an immediate demand to withdraw. What additional issue must be assessed?

The investor’s willingness to bear risk and accept withdrawal restrictions still needs assessment. Wealth alone does not establish emotional tolerance or a compatible investment horizon. Remember: Risk capacity and risk tolerance are different aspects of suitability.

Hint Separate the financial ability to bear a loss from the willingness to experience one. Common mistake: Using wealth as the sole measure of willingness to take investment risk.

XIX-A-099

From the practice bank · 19

An investor selects four funds with different managers. Each fund has substantial exposure to the same narrow industry and several of the same businesses. What should the portfolio review focus on?

The review should aggregate underlying exposures across the funds. Several funds can still leave the investor concentrated in the same companies or industry. Remember: Diversification must be assessed on a look-through basis.

Hint Look through the fund labels to the businesses and sectors actually owned. Common mistake: Counting funds instead of examining shared underlying risk.

XIX-A-100

From the practice bank · 20

Why should an investor examine the repayment resources behind a carried-interest clawback?

A clawback may be difficult to collect if the liable party lacks resources or the mechanism is weak. Due diligence should examine practical recovery arrangements as well as the wording. Remember: A protection is only as useful as its scope and practical enforceability.

Hint Distinguish the existence of a legal claim from the practical ability to recover money. Common mistake: Stopping at the existence of a protective clause without assessing recovery.

XIX-A-101

From the practice bank · 21

A manager offers selected investors a separate co-investment alongside its fund. The proposed allocation of transaction expenses would leave the main fund bearing costs for both groups, and no supporting policy is provided. What requires scrutiny?

The allocation of costs and opportunities needs review for fairness and consistency with applicable arrangements. A co-investment opportunity does not justify shifting unsupported costs to other investors. Remember: Co-investment diligence includes who pays, who benefits and how conflicts are managed.

Hint Follow which investor group benefits from each expense and which group pays it. Common mistake: Focusing only on access to a deal while ignoring expense allocation.

XIX-A-102

From the practice bank · 22

When a fund claims to consider environmental, social and governance risks, what evidence most directly tests that claim?

Documented assessments linked to investment decisions provide evidence that material environmental, social and governance risks are considered. Labels and general policy statements alone do not show implementation. Remember: Test environmental, social and governance claims through evidence of implementation.

Hint Distinguish a stated policy from evidence that it influences decisions. Common mistake: Treating sustainability language as proof of a functioning investment process.

XIX-A-103

From the practice bank · 23

A manager shows an attractive fund return and says the result reflects a repeatable process. Most gains come from one unsold business valued using an unusually high multiple, while the rest of the portfolio is flat. What should the investor do next?

The investor should test the dominant valuation and assess whether the result is concentrated and repeatable. A single estimated gain can make an aggregate track record look stronger than the underlying evidence. Remember: Investigate the sources of performance, not only the headline number.

Hint Ask what actually drives the result and how much evidence supports that driver. Common mistake: Treating an aggregate return as proof of a consistently successful process.

XIX-A-104
Liquidity

Liquidity in the stock market means how easily a quantity can be bought or sold.

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