Managers have an obligation to invest fund assets in the manner in which the fund documents describe, and do so with due skill, care and diligence.
Managers should conduct their own due diligence prior to making an investment in the fund. Due diligence may include delving into the target investment's financial position, management team's ability and expertise, protection of intellectual property, rental values, quality of stock, ESG factors and so forth.
Investors seek an integrated approach for ESG across an asset manager's business and investment policies. ESG evaluation should be conducted against a suitable framework for your asset class, possibly taking into account the future increase or decrease in an asset's value against ESG considerations and reporting to investors around ESG matters should happen on a regular basis.
The results of any due diligence conducted and recommendations from the fund manager should be laid out in a written, comprehensive proposal document, outlining all the relevant financial and non-financial factors. Those involved in recommending an investment should of course be of suitable seniority and hold the requisite experience to make that recommendation. This document will be important when it comes to evaluating the performance of the investment over time.
Investments can be structured in any number of ways and consideration should be given to the investment's jurisdiction, the fund's strategy, whether an investment is being made alongside other investors and what obligations may arise as a result. Managers should gain legal and other professional advice where the structure of the investment imposes ongoing obligations on the fund.
Of course, every investment should be made with an exit plan in mind, part of the initial investment proposal. The sale of an investment will have various implications, such as tax ramifications, and the timing and best way to dispose of the asset can be discussed with outside experts who specialise in your asset class.
It is important that the team is fully committed to the investment valuation process and can talk succinctly to investors about the same. Someone within the team must understand in detail the valuation approach and demonstrate oversight.
Asset managers must gain appropriate legal advice on the balance of the requirement to monitor and report on ESG factors affecting their investments and any legal responsibility around the confidentiality of the underlying holding. If the asset manager is investing in a company, then specific rights will need to be agreed in advance in order to allow the manager to report back to its own investors on these matters, without breaching confidentiality. In turn, the manager will likely need a separate agreement with its investors, in respect of the confidential information being shared with them. It may also be required to report back to regulators on ESG factors, depending on jurisdiction.
Generally, today’s investors expect asset managers to encourage responsible business practice and investing within their portfolio holdings.
Each factor is discussed briefly below, with some examples of the type of activity the portfolio company could undertake given.
Environmental impact: Consideration should be given to the opportunities and risks that may affect the manager’s portfolio in regards to the wider environment. Risks can include emissions (air and water), waste generation and removal, resource depletion (such as water scarcity), carbon footprint and climate change. Opportunities would include resource efficiency, green energy and more. This analysis should be extended to the portfolio company’s supply chain.
Social impact: This could be anything affecting a wider community, company’s suppliers, staff or customers and can include community engagement, health and safety or human rights issues.
Governance: Corporate governance includes the systems, processes and controls a company applies to ensure the effective and compliant running of its business. Asset managers can encourage the adoption of better practice whilst also protecting the independence of the underlying investment. Studies show that better governance practices generally lead to higher asset valuations.
Managed badly, any one of these factors can have grave reputational or legal consequences for the underlying holding, but also for any entity associated with it, including the fund, wider asset management group and their investors.
Managers need to consider what will be distributed and to which investor, including carried interest and waterfall calculations, distribution of losses, tax considerations and so forth. Further consideration should be given to the fund’s cashflow and how distributions affect available capital. These and any other distribution provisions should be outlined and made in line with the fund’s documents.
Distributions should be made in line with the fund’s documents, and should be considered in the context of liabilities including for tax, clawbacks, warranties and indemnities that may have been provided by the asset manager to investors, and any other contingent liabilities. Legal advice should be taken where the asset manager reasonably believes that making a distribution to investor would cause the fund to become insolvent.
This term refers to distributions made through the transfer of ownership of an asset rather than the distribution of the cash value of that asset. Whilst technically difficult to implement, it may be preferred by asset managers when cash isn't readily available, or where it’s more practical to transfer the asset itself. In specie distributions may also have tax ramifications, such as avoiding triggering capital gains tax. External advisors such as fund administrators can ensure that an asset is transferred to investors correctly and can advise about any tax considerations to keep in mind, throughout the relevant jurisdictions.
Make sure you keep interested parties (that did not commit to your fund) appraised with material developments in the portfolio so that they are up to date when you are back in the market. But only when it is big news - if you update them too often, it will become noise.
