Due diligence to ramp up long-only scrutiny: Castle Hall

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Due diligence in funds management tends to be focused on hedge funds because of their sophisticated, sometimes complicated, investment strategies and often small capital backing. But specialist due diligence firms, such as Castle Hall, are branching out into the traditional long-only world.

Castle Hall, a global due diligence (DD) company, already provides services which look under the bonnet of hedge fund managers and private equity general partners. Prompted by some recent investor troubles with several high-profile long-only managers, which better due diligence might have prevented, the firm is producing a series of briefing notes and case studies, the first called: ‘It’s Time for Long Only Due Diligence’.

Subsequent notes in the series look closely at what went wrong with the celebrated UK manager Woodford, which has seen its flagship LF Woodford Equity Income Fund, now suspended. The suspension has caused some grief for Australian-based administrator Link Group, which took on Woodford when it bought the former UK administration company Capita.

Woodford got around a regulatory hurdle for European UCITS funds which limits their holding in private companies to 10 per cent of the portfolio by ‘listing’ some on the small The International Stock Exchange (TISE), based on the island of Guernsey. The trouble is none of the stocks ever traded one share after the listings.

Castle Hall says that the former Capita had form with the regulators. It paid compensation to investors hit by a fund scandal over their Arch Cru investments in 2012 and then again to investors in 2017 over losses in the collapse of the Connaught fund. Other examples mentioned include:

  • GAM’s absolute return bond fund (although that was not long only) which allegedly bought illiquid bonds and closed down after Australian investors, led by their consultant JANA, withdrew $3 billion last year
  • H2O, a fund manager owned by Natixis, which Morningstar suspended from ratings after discovering it had allocated more than one billion euros to bonds from European companies linked to controversial German financier and former bankrupt Lars Windhorst. Windhorst has had several court actions against him, including one from Berlin’s public prosecutor for alleged fraud, and
  • Invesco Perpetual, then the largest retail manager in the UK, who Neil Woodford used to work for, fined for a raft of compliance and accounting problems, including taking up to 27 days to record bond trades and breaches of diversification rules.

Castle Hall says: “Third-party asset managers are vendors in the asset owner’s supply chain. Long-only managers may offer services through managed accounts, private funds or public funds: but in all cases, institutional investors now require systematic, consistent and comparable due diligence information. Investor due diligence policies, and long only managers’ due diligence responses, will evolve to reflect this new normal.”

Alex Wise, the Australian head of Castle Hall, said: “The Woodford case and others like it have highlighted that gatekeepers and regulators have fallen short in terms of investor protection. Locally, many investors rely solely on the investment research of retail funds. This case shows thorough and independent operational DD is very much required as well.”

– G.B.

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