It’s 10-Q review season again, and at FactRight and FR Risk Management, we’re assessing the filings for many public, non-listed investment programs and updating our ongoing reviews for our clients. It’s a good time to share pointers on how to perform efficient and effective due diligence on platform programs through reviews of quarterly filings.
Before we dive into how to review a 10-Q or 10-K, a word about monitoring processes globally. Ongoing due diligence is a process of continually reducing or mitigating investment risk. This task is easier with a defined review structure in place. The due diligence process does not need to be complicated, just thorough. Here are four steps to developing a quality ongoing monitoring program:
Step 1: Review each platform offering on at least a quarterly basis. In particular, look for changes in the following factors:
Step 2: Evaluate how each of these factors affects risk to your clients.
Step 3: Document your conclusions, describing specifically how they are based on your analysis.
Step 4: Archive your conclusions regularly to maintain proof of compliance
Following this process demonstrates not only product expertise but also ensures a continuing quality platform of offerings. Most importantly, it demonstrates why your recommendations are in the client’s best interest.
The length of public fund filings can make it challenging to find changes in investor risk in an efficient and timely manner. In fact, Deloitte reports that the length of quarterly and annual filings has more than tripled since the 1990s. Fortunately, the consistent structure of these filings simplifies the process for evaluating risk. For example, web applications such as BamSEC or Contexxia allow you to compare the filings’ text over time and highlight where changes have occurred. Any redrafted language may signify changes in risk that might otherwise have been obscured.
The following descriptions explain where to look for red flags in 10-Qs and 10-Ks for non-traded REITs and BDCs that may suggest a fund is no longer a prudent investment. The legal reporting requirements for these forms are very strict, so the quality of their information is high. (Unfortunately, other types of investment programs have different reporting requirements and therefore different filing structures from non-traded REITs and BDCs. However, the basic strategy for ongoing due diligence remains the same.)
Distributions are a key reason people seek out alternative investments. Review the fund’s distribution coverage, and analyze the trends for increased investor risk related to fund performance, including whether fees are impacting financial performance and the sustainability of distributions. Fund performance should be evaluated in the context of current market conditions to understand what is driving fund changes.
Footnotes (found in the Financial Statements section) are where issuers often disclose valuable portfolio information, especially in BDCs. With REITs, footnotes are also where issuers often disclose recent or pending acquisitions that can alert you to drifts in the offering’s investment strategy.
Tip: Footnote numbers rarely change between quarterly reports, so changes in wording are often easy to review.
These include:
Other quarterly filing sections may contain red flags, including:
An efficient ongoing due diligence process, performed quarterly and documented and stored appropriately, will both lower your risk regarding fiduciary compliance as well as demonstrate your firm’s commitment to your client’s best interest.
For more practice tips on ongoing due diligence and how to review quarterly filings, see the webinar I presented entitled “Mitigating Risks with Ongoing Reviews.”