The due-diligence checklist before you act

# The due-diligence checklist before you act

A colleague forwards you a fund fact sheet. The headline says "+14.2% annualized over 5 years, top-quartile performance." Your instinct is to nod and move on. Don't. That single line hides at least four questions that decide whether the number is real or cosmetic. This lesson is the checklist you run before you act.

Start with the fact sheet, but never trust it alone

A fact sheet (also called a KIID or KID in Europe) is the one-page marketing summary a fund publishes monthly. In the EU it is standardized as a KID (Key Information Document), required under the PRIIPs regulation (Packaged Retail and Insurance-based Investment Products). In the US, the equivalent disclosures live in the prospectus and summary prospectus filed with the SEC (Securities and Exchange Commission).

The fact sheet is written to sell. Your job is to cross-check it against an independent source.

The standard move: open the fund on Morningstar and compare. Morningstar recalculates returns, assigns a category, and shows the peer percentile. If the fact sheet claims "top quartile" but Morningstar puts it in the third quartile, someone chose a flattering time window or a soft benchmark.

Check the benchmark is honest

A benchmark is the index a fund measures itself against (for example, the MSCI World for a global equity fund, or the Bloomberg Global Aggregate for bonds).

Two red flags:

• Benchmark mismatch. A fund holding 40% US tech but comparing itself to a broad global index is picking an easy opponent. Confirm the benchmark reflects what the fund actually holds.
• No benchmark shown at all. For an active fund, this is a tell. If they beat the market, they show it.

Simple test: does the fund report returns *net of fees* against the *total return* version of the index (dividends reinvested)? Comparing net-of-fee fund returns to a price-only index inflates the apparent outperformance.

Verify the track record: survivorship bias

Survivorship bias is the distortion you get when failed funds disappear from the sample. Asset managers routinely close or merge poor performers into stronger ones. The graveyard vanishes, and the surviving average looks better than reality.

How to spot it:

• Was this fund merged from a predecessor? Check the inception date against the track record shown. A "10-year record" on a fund launched three years ago usually means a merged history.
• Is the strategy shown at the share class or composite level? A composite can quietly drop closed accounts.

For a manager pitching a whole fund range, ask the blunt question: "How many funds did you close or merge in the last five years?" The answer reframes the survivors.

Sanity-check the fees: TER versus peers

TER (Total Expense Ratio) is the annual running cost of a fund as a percentage of assets. In the US you will more often see the expense ratio or OCF (Ongoing Charges Figure) in Europe. Same idea: what you pay every year, win or lose.

Rough peer anchors (industry estimates, as of 2025, vary by domicile and share class):

• Passive equity index funds and ETFs: often 0.03% to 0.20%.
• Active equity funds: commonly 0.60% to 1.50%.
• Active bond funds: commonly 0.40% to 1.00%.

If an active global equity fund quotes a 2.0% TER, it is expensive relative to peers and needs to justify that with genuine, repeatable outperformance.

A worked calculation: does the fee eat the alpha?

Alpha is the return above the benchmark that the manager claims to add through skill.

Suppose a fund shows:

• Gross return: 9.0% per year
• Benchmark: 7.5% per year
• Gross alpha: 1.5%
• TER: 1.2%

Net alpha = gross alpha minus TER = 1.5% - 1.2% = 0.3%.

The manager generated 1.5% of skill and kept most of it in fees. You are left with 0.3% for the extra risk and effort of picking an active fund. Now compare that to a passive alternative charging 0.10%. The active case has to be strong.

Compound it to see the drag. On a 100,000 investment, a 1.2% TER costs roughly 1,200 in year one, and because it compounds on a shrinking base, the ten-year cost is far more than 12,000.

Confirm the vehicle: domicile and liquidity

The wrapper matters as much as the strategy.

Domicile is the country where the fund is legally registered. This drives tax, regulation, and who can buy it.

• In Europe, most cross-border funds are UCITS (Undertakings for Collective Investment in Transferable Securities), typically domiciled in Luxembourg or Ireland. UCITS carry strict diversification and liquidity rules, which is why they are sold in dozens of countries.
• In the US, the workhorse is the '40 Act fund (a mutual fund or ETF governed by the Investment Company Act of 1940).

Why you check: a US investor generally cannot buy a Luxembourg UCITS retail share class, and a European investor often cannot buy a US '40 Act fund. Domicile also affects withholding tax on dividends.

Liquidity terms: can you actually get out?

Liquidity is how quickly you can redeem (sell back) your investment.

• A daily-dealing UCITS or an ETF: you can typically exit any business day.
• A private credit, real estate, or hedge fund vehicle: may have lock-ups (a period where you cannot redeem), gates (caps on how much can be withdrawn at once), and quarterly or annual redemption windows.

The 2022 to 2023 stress in some open-ended property funds, which suspended redemptions, is the cautionary tale: investors thought they had daily liquidity on inherently illiquid assets. Always match the vehicle's liquidity to the liquidity of what it holds.

Sizing the field: know the numbers

Context for any single fund. Global assets under management (AUM) are estimated at roughly 120 trillion USD as of 2024 (industry estimates; figures vary by source and definition). The US is the largest single market, and passive vehicles now account for a very large and growing share of US equity fund assets, having crossed roughly half in recent years (estimate). Europe's fund industry is dominated by UCITS domiciled in Luxembourg and Ireland.

The direction of travel is consistent: fees compress, passive gains share, and money concentrates in the largest managers (BlackRock, Vanguard, State Street, and in Europe firms like Amundi). That balance of power is exactly why fee and benchmark checks matter more each year.

Red flags in flow and performance numbers

Two datasets reveal problems the fact sheet hides.

Fund flows are the net money coming in or going out. Persistent outflows can force a manager to sell holdings to meet redemptions, which hurts remaining investors and can shrink the fund below a viable size.

Red flags:

• Rapid AUM growth in a strategy that relies on small, illiquid positions. Size kills certain strategies; a small-cap fund that ballooned may no longer be able to trade nimbly.
• Heavy outflows paired with steady reported returns. Ask what is being sold to fund redemptions.

Performance pattern flags:

• Returns that are suspiciously smooth. Real markets are volatile. Unnaturally steady monthly gains were the signature of past frauds.
• A style drift: the fund's holdings no longer match its stated mandate. A "value" fund stuffed with momentum tech has changed its risk without telling you.
• Outperformance driven entirely by one or two years. Look at rolling returns, not just the cumulative headline.

Cross-reference the manager's own reported numbers with the SEC filings (US) or the annual and semi-annual reports (Europe). If the marketing and the audited report disagree, the audited report wins.

Key Takeaways

• Never act on the fact sheet alone. Cross-check returns, category, and peer percentile against an independent source like Morningstar, and confirm the benchmark is a fair, total-return match.