How to spot a dodgy investment fund

Due Diligence is a major money maker for professional firms, especially during heady days of take-over and merger activity. This is a fancy term for research to establish the truth behind financial statements.

When a company is going to buy another company, merge with it, or merely take a stake, it has to employ an army of accountants and lawyers to try to discover if the company really is exactly what it says it is.

Are the assets what they seem? Do they have clear legal title to all they claim to own? Are there more debts that those stated? Are the assets accurately specified? What are the liabilities? Is there any damaging litigation in the offing? Are the owners and managers of the firm hiding anything of material importance, and are they of good standing? These and more are the areas that are investigated when companies invest in each other.

In view of the potential pitfalls endemic to investing offshore, it is a great pity that more advisers often do not put into practice some simple due diligence procedures before recommending funds to their clients. Instead they count their commission cheques and cross their fingers for miraculous investment performance to hide risks and fees from their trusting client.

Of course, when you are investing there are no guarantees. But a few simple questions can help reveal those funds it might be best to avoid.

Name - although size and reputation is no absolute protection against fraud or mismanagement - for example, Enron, Barings and Allied Irish Bank - the bigger the name and the longer they have been doing business, the more secure a company should be. If you have never heard of the proposed fund, you should not run, but do make a mental note that the rest of the investment case has to stack up.

Regulation and Domicile - in this day and age there are many offshore investment locations that happily blend tax and cost efficiency with good regulatory protection. These are areas where regulators insist on a fair degree of financial probity from the funds they allow in. If the fund that you are considering is not domiciled in one of the major regimes then ask why. There must be a good reason why a fund would be domiciled in a location with little or no regulation. Is it because they can not meet more exacting requirements, or can not meet the costs?

Size - like name and previous good reputation, size itself is not a protection from fraud or loss, but it does provide some re-assurance. So are you dealing with an institution of some magnitude? After all there are many investment specialists that are not household names. So if you find that a name you have never heard of is a multimillion dollar business, then you can be re-assured.

Fund Size - size is also very important when a specific fund is concerned. If you are investing $100,000 in a fund worth only one million dollars, then you are more at risk than in a $100 million fund. What happens if the fund's value drops and the other investors take flight? With a small fund you can be left with all the costs and face the cost of winding up the fund. And bear in mind, the manager and administrator will take their fees before they let you have your money back.

Fund Valuation and Dealing frequency - how quickly can you exit from the fund? Does it deal daily (the most preferred, if expensive option) weekly or monthly? The more frequent the valuations and dealing dates the better. What is the redemption period? I.e. how quickly after you have sold will you get your hands on your money?

Charges - what are the initial fees? What is the bid to offer spread? Are there any redemption charges? And do they reduce with time? And what are the annual management charges - anything more than 1.75% pa should be viewed with caution

Auditors, bankers and legal advisors - Can you get a list of these firms? Every fund should have them. Are their names familiar? If you haven't heard of the fund manager, or any of their professional advisers, or if the names are not available then it might be wise to look elsewhere.

Major Fund Assets - ask to see a list of the ten largest assets within the fund, and the geographical split, or other information on the actual assets within the fund. Again, a warning sign is the non-availability of this list, or a list full of un-familiar assets.

None of these items above are necessarily a reason to avoid investing your money into a fund. But if there are several unsatisfactory aspects, then bells should start to ring the old warning, 'Un-clean! Unclean! Keep away!'