Paterson & Associates Minimizing Risk to Maximize Returns – Product Due Diligence Presented by Dave Paterson, CFA

Paterson & Associates Who We Are Independent consulting firm providing mutual fund & hedge fund research, product due diligence, and portfolio optimization services Founded in May 2002 Over 12 years financial industry experience Awarded CFA designation in 2000

Paterson & Associates Product Due Diligence Due Diligence is the process of research and analysis that takes place in advance of an investment. Process seeks to confirm all material facts and determine risks associated with the investment In simplest terms, you’re seeking the answer to two very basic questions 1. What are you going to be investing in? 2. Who are you dealing with?

Paterson & Associates Why conduct Due Diligence? Because the MFDA said so. Helps you look at a product and/or company more objectively. Helps to greatly reduce probability of investing clients money in a “bad” investment. Following a consistent, systematic process will provide some degree of protection in the event of a client complaint.

Paterson & Associates Due Diligence – The Process A multi step process. Steps required will depend on complexity of the product. the more complicated the product, the more detailed the analysis needs to be.

Paterson & Associates Step 1 – Product Identification What exactly is the product that you are going to look at? – Is it a mutual fund, a hedge fund, a PPN, LSIF, LP… You will also want to know how the product is offered. – Simplified Prospectus, Offering Memorandum, Information Statement, or other documentation? This helps determine degree of analysis required.

Paterson & Associates Step 2 – Company Analysis Familiarize yourself with the company on such things as: – History – Assets under admin – Number of employees – Management – Ownership Structure & Credit Worthiness – Operational Aspects (including Disaster Recovery Plan)

Paterson & Associates Step 3 – Product Details Determine the specific details for the product – Involves line by line review of offering documents paying particular attention to fees, use of proceeds and investment restrictions/process sections. Look for such things as: – Investment Objective – Investment Process & Restrictions – Manager – Commissions & Fees – Custodian, Auditor, Legal Advisor, Calculation Agent, Guarantor – Liquidity

Paterson & Associates Step 3 – Investment Objective What is this product trying to accomplish? What strategies is the manager going to use to meet the investment objectives? Does this look to be a realistic objective?

Paterson & Associates Step 3 – Investment Process & Restrictions What is the manager’s investment process, including security selection process, risk management process, and sell discipline? What can or can’t the manager invest in? Can they use leverage, short stocks or use any derivatives? – What are the restrictions on those activities? Are there any other terms and conditions you need to be aware of?

Paterson & Associates Step 3 – Manager Analysis Who is managing the product? – Is it an in house manager or external manager – What is their track record? – What are their assets under administration? – What are the manager’s fees? What other mandates does the manager run? What strategies will the manager employ?

Paterson & Associates Step 3 – Commissions & Fees What is the commission & trailer that is paid on the investment and how does it compare to other, similar investments? What are the costs associated with the product? – Be sure to consider both the explicit and implicit costs

Paterson & Associates Step 3 – Related Parties Determine what companies act as: – Custodian – Auditor – Legal advisor – Calculation agent – Guarantor Make sure that the companies involved are all name brand firms and are not affiliated entities.

Paterson & Associates Step 3 – Liquidity Is there a lock up period? How often is the product priced? Is there a secondary market? – What conditions exist in the secondary market? – How is product priced in secondary market? Is there a notice period before you can redeem? Does the liquidity of the fund match the liquidity of the underlying investment?

Paterson & Associates Step 4 - Risks Determine the specific risks associated with the investment – Investment risks – Return drivers – Operational Risks of Offering Company – Credit Risks – Liquidity Risks

Paterson & Associates Step 5 – Investor Suitability How does this investment fit in a portfolio? Who is this investment suitable for? – Who should not invest in this product? What is the highest exposure an investor should have within their portfolio? – Based on risks of product and investor profile

Paterson & Associates Basic Criteria / Red Flags – Mutual Funds Minimum 3 year operating history Assets under admin of at least $500 million High quality management team Strong investment team with a clearly defined investment process Name brand custodians, auditors, legal advisors

Paterson & Associates Basic Criteria / Red Flags – PPN’s Issuer / Guarantor with a AA credit rating Clear, plain and true disclosure of all costs, both explicit and implicit An easy to understand return calculation Exposure to an underlying investment which is something more than just a plain mutual fund with a principal guarantee At least weekly liquidity, efficient secondary market

Paterson & Associates Basic Criteria / Red Flags – Hedge Funds Minimum 36 months operating history Assets under admin of at least $100 Million Experienced, high quality management team Stable ownership, preferably partially owned by investment managers and employees External NAV Calculation Agent Regular liquidity Name brand auditors, custodians, & legal advisors Clearly articulated investment process & restrictions Audited financial statements for every year they are showing performance numbers Full, plain, true and ONGOING disclosure

Paterson & Associates Product Due Diligence Q&A