Fund Industry Arbiters Gain Ground

Due diligence professionals are branching out from the institutional to the individual investor market.

These are the financial mechanics who "kick the tires" beneath investment products and the companies that manage them. Recruiters point to growing demand for these analysts to pass judgment on both traditional and alternative asset-management strategies that financial advisors provide to high-net-worth clients.

The need is "huge," says Dave Tomer, president of Tomer Search Group, a Boston-based recruiter. "We've got openings now across the board" within private banking divisions and fund-of-funds managers, he says.

However, due diligence pros earn less than either marketers or financial advisors with comparable levels of experience, and far less than portfolio managers. Some observers contend those gaps must narrow in order to correct a shortage that threatens to cap one of Wall Street's hottest growth areas, separately managed accounts.

A Wide Range of Tasks

Thanks to the 1974 ERISA law, which required private-sector pension funds be managed to professional standards, the due diligence function has long been prominent in institutional asset management. In recent years its influence has extended into the retail market, a consequence of the hedge fund explosion and Wall Street's heightened focus on wealthy individual investors.

ERISA gave birth to an industry of consulting firms that act as institutions' gatekeepers for any fund company that wants to manage a portion of their money. Today, the top global banks and brokerage houses are building similar capabilities in-house as a way to attract more assets to their fee-based advisory services.

"Due diligence" embraces a range of tasks aimed at determining whether a specific money manager or product operates in line with stated objectives, and is suitable for a particular investor. According to Financial Advisor magazine, areas that must be researched include a manager's trading system, operation and administrative functions, fee structures, possible conflicts of interest, management style, marketing materials, business plan, method of handling "market instability," flexibility, technology, performance reporting methods, and how the manager's costs impact investors' returns. And that's only a partial list.

Assessing numerous managers' past returns and risk statistics is a critical part of the process. "You have to be able to figure out performance," says Tomer. "That requires a good grasp of technology as well. The data bases are so big now, you have to be able to screen them."

Qualifications and Compensation

A junior-level due diligence person is primarily a data analyst of fund performance. Employers' specifications often call for a math or computer science degree, plus experience in statistical modeling, knowledge of Matlab or SAS software and Monte Carlo simulation, along with an understanding of asset allocation and performance measurement. Compensation would be $100,000 to $125,000 base and a bonus of 25 to 50 percent, according to Tomer. This would apply to a person with strong technical skills, but no CFA designation.

At a more senior level, a person with five years' experience and a solid investment background plus technical skills can expect a base of $140,000 to $150,000 and a 100 to 200 percent bonus. Roles at this level tend to involve at least some client contact.

Both pay and advancement opportunities leave much to be desired, says buy-side recruiter Mark Elzweig, president of Mark Elzweig Co. In a January 2007 article in Investment News, Elzweig and co-author Nancy Miller urged Wall Street to "give due diligence pros their due."

"Turnover is so high that one fund-of-funds manager said he can't remember the names of the analysts who visit," they wrote. "One major Wall Street firm saw half of its staff turn over last year....

"We see many analysts playing hopscotch from firm to firm for incremental pay raises. Many leave the field altogether for product management or marketing positions, which pay significantly more."

Hedge Funds up the Ante

The addition of hedge funds to the mainstream product menu injects a new element. Not only are their portfolios and performance numbers more idiosyncratic than long-only products, the fund companies themselves are harder to assess than the typical large, established institutional management firm.

Analysts who perform due diligence on alternative investments such as hedge funds, real estate and private equity can earn considerably more than those who focus on traditional investment managers, according to Elzweig and Miller. They're also in greater demand.

Although the authors report seeing more hedge fund due diligence analysts with sophisticated training, they conclude there is still work to be done: "To attract good people, compensation and training must put talented executives on an attractive career path."

At least two industry organizations offer a credential closely related to due diligence work. The Investment Management Consultants Association awards the designation of "Certified Investment Management Analyst" (CIMA) for successfully completing a curriculum including asset allocation, manager search and selection, investment policy and performance measurement. The CFA Institute last year launched a Certificate in Investment Performance Measurement (CIPM) designation, designed for specialists who compute and evaluate portfolio performance.