Investment Due Diligence. Asking the Right Questions [video]

Jan 25, 2023 9:10:48 AM

During the pandemic, trends shifted significantly, and RIAs are embracing a new normal that revolves around paperless offices and working from home, among other trends. 

With all the perks that come with this new workforce flexibility, there are vulnerabilities. As a result, due diligence is more important than ever, and the SEC is keeping a more watchful eye on the regulation of financial services firms. 

RIAs and money managers must take steps to protect their practices and their clients. Cybersecurity is a start, but the list should include other due diligence steps to ensure that all new regulations are followed. Most importantly, investment strategies should align correctly with clients' needs and long-term goals. 

Asking the right questions  

Asking Why 

Most individual investors, managers, and RIAs will perform a high-level due diligence process regarding new investment opportunities. Yet, in the current climate, digging deeper is imperative.  

Sakichi Toyoda formally developed the 5 Whys Technique. It was first used within the Toyota Motor Corporation during the manufacturing evolution decades ago to solve problems by drilling down to its root cause by asking “why” 5 times.  

“By repeating why five times, the nature of the problem and its solution becomes clear.” Sakichi Toyoda  

Vineyard CEO Clark Richard offers insight into this technique in the following video: 


The method of asking why five times is beneficial when considering how specific investment strategies fit your client's time horizon, goals, and risk tolerance profile. For example, based on the starting point criterion of your client reaching a specific income goal in the next ten to fifteen years, ask yourself why.   

My client will need an extra $500,000 income over the next 15 years to retire by age 60.   

  • Why? They incurred significant losses with another investment firm and are now playing catch up.  
  • Why? Their investment portfolio required a more robust risk-managed framework to protect equity exposure.  
  • Why? They fit a much more conservative investment profile than initially assessed based on their long-term retirement goals and time horizon.   
  • Why? Their risk tolerance was improperly assessed, and investment strategies misaligned with client objectives.  
  • Why? They didn't perform their due diligence to find the right investment strategies.  

This technique is most effective when the answers come from people with hands-on experience with the process or problem. Often it can be used to discover which investment strategy is best for a client’s unique needs.  Finding a manager that embraces this method will lead to due diligence and risk analysis that is tactical and deep. Assessing the "whys" can reveal a clear path to the "how's."   

Investment Research

A Closer Look 

The following is a due diligence checklist to guide the vetting of the right firm or investment manager.  

RIAs need to ask the right questions when vetting an investment manager. It is imperative to perform a deep dive into products, reporting, and adherence to regulations set forth by the SEC, FINRA, and other governing bodies. 

  1. Get very familiar with the SEO filings for the product.  
  2. Make sure your review includes the most current Quarterly Reporting. 
  3. Make a meaningful comparison of quarterly reports over a period of time.  

The amount of information RIAs must consider and review for each investment is copious, and information overload is all but guaranteed. So, look for a partner/manager who will provide transparency - including access to the investment teams if needed. 

Finding Transparency

With the release of the Bernie Madoff Documentary on Netflix and the recent Crypto meltdown as examples, it would be easy to arrive at the incorrect conclusion that we are in the wild west regarding regulations in the investment universe.  

It is the responsibility of the RIA to do the research and all vetting for any investment they will offer to their customers. Setting up a timely monitoring system earns the top spot on a list of initial steps that should be taken. When vetting a manager, you should also consider the following:   

  1. GIPS Certification. Global Investment Performance Standards - the voluntary, ethical standards for calculating and presenting investment performance based on fair representation and full disclosure principles.  
  2. A third-party due diligence report and a manager produced DDQ (due diligence questionnaire).  
  3. Registration status with the SEC, FINRA, or NASAA.  
  4. Form ADV parts 1 and 2 - providing detailed information about the firm, its fees, client types, assets under management, and any disclosures. These are often found on the company website.  
  5. Background check - civil, criminal, or regulatory.  

Check the headlines, set alerts for news about managers and companies, and investigate third-party due diligence AI, which is available for all the above searches. Ask to see the Operational Due Diligence Report to learn more about the company's operational functions. These should be conducted quarterly. 

Preparing for Success

Since finalizing the REG BI (Regulation Best Interest) rules for broker/dealers and registered investment advisors in 2019, the SEC has been working on updating and adding more regulations. Accordingly, RIAs should take preliminary steps to prepare for the new requirements for proposed rule changes in outsourcing and cybersecurity risk management.  

As risk analysis becomes a more significant component of running an RIA business, partnering and outsourcing will need extra attention to oversight and timely monitoring and reporting.

Vineyard Global Advisors offers a range of investment strategies designed to allow participation in the market's growth within a dynamic, risk-managed framework that seeks to offer protection during significant market declines. Our goal is to give our clients greater peace of mind by generating steadier returns over time. 

View Our Investment Strategies                 Connect with a Vineyard Advisor

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