When searching for the best partner to service your mutual fund or hedge fund, it’s critical to follow a well-defined and comprehensive due diligence process. Investment managers and fund boards are faced with increased pressure to understand all aspects of a provider’s operation in order to limit liabilities and risk and justify service expenses.
As regulatory requirements for hedge funds and mutual funds evolve, fund sponsors and boards should implement a formal due diligence process that documents criteria for provider selection and ongoing relationship management. The following due diligence plan provides a framework for selecting the best service provider for your funds. While some components are specific to selecting mutual fund and hedge fund providers, many of these best practices are also applicable to selecting providers across other financial service areas.
Service provider selection criteria
A successful due diligence program should begin by outlining the service criteria and business characteristics of the best possible firm. The best firm will offer the greatest distinction of service capabilities relative to your specific and weighted business and investor needs. Below are some specific components within each selection criteria.
Service provider credentials
- Financial condition
- Firm history, business diversification/concentration
- Service inception, history of each service
- Acquisition history
- Commitment to your specific service businesses
- Firm background check
- Third-party industry ranking – size, quality
- Complete client base
- Specific client base to your similar product, size
- Complete scope of services
- Insurance coverage
- Transparency of information requested
- Client base tenure
- Client turnover – wins/losses and reasons
People and service team
- Management and staff tenure
- Management and staff turnover
- Individuals assigned to your relationship, bios, workload
- Talent sourcing and development programs
- Quality of firm’s reference research results
- Management and service team interview results
- Willingness/ability to customize services
- Frequency of relationship/management interaction
Compliance programs
- Firm regulatory exam results
- Compliance culture, commitment
- Compliance resources and management structure
- Internal training programs
- Internal audit exam programs\
- Third-party audit program, results
- Chief compliance officer resources
- SOC 1/SOC 2 assessment
Service quality programs
- Formal quality control programs – ISO, Lean Six Sigma, etc.
- Key performance indicators (KPIs)
- Service level agreements (SLAs)
- Service measurement programs
- Frequency of client service performance reporting/review
- Continual improvement programs
- SLA service reporting to clients
- KPI measurement automation tools
- External quality verification/testing reporting sources
- Service conversion history, methodology, examples
Technology
- Client data delivery capabilities, reporting
- Core technology infrastructure, history, tenure
- Recent, pending, anticipated technology changes
- Ability to customize for client-specific requirements
- Technology support teams – within/outside the business
- Information security program, test results
- Business continuity plan, program, test results
- External/internal technology dependencies
- Outsourced technology provider management program
- Development methodology
Innovation
- Relationship management focus, attention
- Capability to champion client regulatory change solutions
- Customized services specific to client requirements
- Ability to serve as a resource regarding all industry topics
- Value-add service or support distinctions
- Demonstration of innovative client support
- Technology innovation demonstrated
- Client access to legal and tax resources
Formal due diligence process
You should formalize your service provider due diligence program with a focus on selecting and managing the relationship. The process should contain the following elements in order to support the procedure and decision:
Due diligence plan: Your plan will describe your business goals, the specific factors you will use in selecting the best provider and how you will conduct due diligence.
Research and validation: Early in the process, identify all potential providers through research and discussion with industry players such as legal, audit and consulting firms that work with the contending providers. These organizations may be a great source of market intelligence regarding provider distinctions.
Documentation: Develop thorough and detailed documentation either directly or through a formal Request for Proposal (RFP).
Analysis: The single greatest component of your due diligence plan is objectively analyzing your findings and identifying the differences between providers that will matter most to you and your investors.
Recommendation: The results of a successful due diligence process should come from your formal methodology and data analysis.
Expectations of service providers
Before entering a formal relationship with a service provider, you should expect complete transparency into all aspects of the service provider’s business. If the provider chooses not to disclose certain requested information, you need to determine how critical that information is to your selection.
As you prepare for and conduct your due diligence of the different providers, keep in mind the two greatest criteria for any business – talent and technology. These two resources drive all other criteria, service capability, success and risk of any business relationship. In addition, your primary goal in performing due diligence is to assess and quantify risks, including risks associated with your service provider selection – financial, operational, personnel and compliance risks.
Finally, throughout the process, you will discover how each firm will service your fund, resolve problems and define success. Make sure each firm provides not only a discussion, but also a demonstration of their abilities, including examples of your required services.
Our financial environment demands increased regulations, leaner business practices and more sophisticated technology. More than ever, investment managers must perform rigorous diligence on all fund services in order to support investor and regulatory scrutiny. A comprehensive due diligence program will identify the optimal service provider, minimize risk and help ensure high quality services for investors.
Learn more about global fund solutions to support investment strategies and products, including mutual funds, alternative investments and exchange-traded funds.
Bob Kern worked for U.S. Bank from 1982 to 2018. In his most recent role before retiring, he managed global business development efforts of mutual fund, exchange-traded fund and alternative investment product services in the U.S. and Europe.
U.S. Bank does not guarantee the products, services, or performance of its affiliates and third-party providers.
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