Due Diligence & Fund Selection Flashcards
7 cards from real CFM practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 7 Due Diligence & Fund Selection flashcards as text
A fund manager presents a 5-year track record with a Sharpe ratio of 1.5, but the entire track record was generated at a prior firm. Under GIPS standards, how should this 'portable alpha' track record be treated?
Answer: It may be presented only if the team and process are substantially intact and properly disclosed
GIPS allows portability of track records from prior firms only if the investment decision-making process is substantially similar and the claim is properly disclosed.
Which due diligence finding most directly raises concerns about a fund's valuation independence?
Answer: The portfolio manager has authority to override third-party valuations for Level 3 assets
Allowing portfolio managers to override independent valuations for hard-to-price assets creates a severe conflict of interest and undermines valuation integrity.
In the context of hedge fund due diligence, what is the significance of a fund's 'capacity constraint'?
Answer: The AUM level beyond which the strategy's returns may deteriorate due to market impact
Capacity constraints arise because some strategies, especially in less liquid markets, cannot be scaled without the fund's own trading moving prices against itself.
During qualitative due diligence, an analyst interviews multiple former employees of a fund who describe a culture of intimidation and suppression of risk concerns. This should be weighted as:
Answer: A significant governance red flag that may indicate elevated operational and fraud risk
A culture that suppresses risk-raising is a governance failure that historically precedes operational failures and fraud, as seen in cases like Madoff and Amaranth.
Which factor would most likely cause an investor to reject an otherwise attractive fund during the final stage of due diligence?
Answer: An unresolved SEC investigation disclosed in the fund's Form ADV
An unresolved regulatory investigation represents material legal and reputational risk that can threaten the fund's ability to operate, making it a potential deal-breaker.
What is 'look-through' analysis in the context of fund of funds due diligence?
Answer: Aggregating underlying fund positions to assess true portfolio-level exposures and concentrations
Look-through analysis consolidates all underlying holdings across manager allocations to reveal the fund of funds' true exposure to specific securities, sectors, or risk factors.
A pension fund is selecting between an active equity fund with 2% tracking error and a passive index fund. Which scenario would most justify paying the higher fees for the active fund?
Answer: The manager has demonstrated statistically significant alpha net of fees over a full market cycle
Active management fees are only justified when a manager can demonstrate persistent, statistically significant net-of-fee alpha across different market conditions.