Since investments in hedge funds are more illiquid than traditional mutual fund investments with long initial lockup periods and only periodic redemption dates, investors won't be able to quickly withdraw their money from the fund if it starts to perform badly. In order to protect against losses. Investors into hedge funds often carry out extensive due diligence before making an investment into the fund so that the risk of any surprises is minimized.

The best practices for the types of due diligence that should be carried out include, a review of the corporate organization of the hedge fund and hedge fund management company. This can be carried out by examining incorporation, certificates, minute books, joint venture agreements, subsidiaries and group structure charts. Public documents will be reviewed as part of the due diligence investigations. These might include any file documents, internet searches, and management searches. Financial statements and forecasts are a key element of due diligence. Investors should examine, audited and unaudited, consolidated financial statements, monthly reports, letters to auditors, and budget protections from management. The tax strategy and positions of the hedge fund can range from being of fundamental importance to the performance of the fund at one end of the scale, but could also be totally inconsequential. This will vary based on the strategy of the fund. However, it is important that a fundamental review of tax documentation should be carried out. These documents might include copies of tax returns and audits, any notices received disputes, changes in law, and any potential tax liabilities. Previous audit information will also be of interest to potential new investors. Factors to be considered will include changes in accounting policies, the relationship with internal and external auditors. Internal accounting controls, audit opinions, post audit releases, accounting systems and related party transactions. Management and employees are vital to all businesses. It is therefore a fundamental element of due diligence. Factors to consider will include the prior experience and reputation of the fund managers, any significant defections, key person, risk copies of the employee handbooks and organizational charts. Insurance verification should also be of interest when performing due diligence checks to reduce the risk of loss to investors. Should an unforseen event occur? Such a review would seek to examine copies of policies, key person insurance, product liability, and professional indemnity insurance. Legal considerations may also be evaluated, including but not limited to, a review of historic and current litigation pleadings and regulatory compliance communication. Many other sources of information will also be of interest. In truth, there is not an exhaustive list, but investors might also consider reviewing the fund, prospectus other ad hoc financial data as well as investor communications.