Emerging Managers
Formation and Evaluation
Brian T. Bares, CFA
1
EMERGING MANAGER INTRODUCTION
2
EMERGING MANAGER FORMATION
3
EVALUATING EMERGING MANAGERS
4
WHAT NEEDS TO CHANGE
What is an EM?
• Emerging Managers are:
– Small (low levels of AUM)
– Young (less than 5 years old)
– Owner/Operators
AUM
Typical Manager Lifecycle
Time
Why Emerging Managers?
Better Performance
Supporting Comments
“Hedge Funds under three years of
age tend to perform better than do
older hedge funds without necessarily
adding to the volatility of returns.”
- Lazard Asset Mgmt Study
Supporting Comments
“The annualized returns of Emerging
Managers stood at 9.49% compared
with 7.61% for bigger peers.”
-Neuberger Berman 2011 strategy outlook
Supporting Comments
“Between 1996 and 2008, funds with
less than $100mm delivered 13%
annually compared with 10% for
funds over $500mm.”
- PerTrac Financial Solutions Study
Why Better Performance?
•
•
•
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Freed of legacy positions
Freedom to be more concentrated
Incentive fees
Flexibility with lower AUM
Niche/innovative strategies
Focused and dedicated talent
1
EMERGING MANAGER INTRODUCTION
2
EMERGING MANAGER FORMATION
3
EVALUATING EMERGING MANAGERS
4
WHAT NEEDS TO CHANGE
What Does It Take?
Breakeven
Insufficient
Recurring Fees
Sufficient
Recurring Fees
What Does it Really Take?
Client’s
Interests
Manager’s
Interests
Optimal AUM
Fundraising
Optimal
Asset Bloat
Investment Return
Optimal AUM
AUM
EM’s Time Choices
Research
Fundraising
Paradox of Investor Demands
Marketing &
Fundraising
Breakeven
Sufficient
Recurring Fees
EMs Need to Market
• Target a receptive niche
• Be proactive in raising your profile
• Market even at optimal AUM
Figure Out Your “Fit”
Real
Assets
Public &
Hedge
1
2
3
4
Private
Equity
Fixed
Income
Examples
Long/Short Equity
Global Macro
Event Driven
One-on-Ones are Critical
Our
Story
Direct Investors
Family Offices
Endowments
Foundations
High Net Worth
Fund of Funds
Seeders
Emerging
Manager
Strategic HNW
Seed Programs
Specialists
Outsourcing Fundraising
• Third Party Marketers
• Can Be Expensive
• EM must still “close”
• Personality must fit
• Prime Broker/Capital Introduction
• Wholesale Relationships
Remember: Institutions rarely invest without
meeting the investment decision makers
Insourcing Fundraising
• Inside Salesperson
• Captive 3rd-party marketing
• Closer to the investment process
• Expensive
Investors will still require one-on-ones with the
decision makers
Databases
Database entry is time consuming but worthwhile
BarclayHedge
Consultants
Lipper
Morningstar
eVestment
Informa
Manager
New Manager Formation
Registration
Service
Providers
1
2
Emerging Manager
Hire Team
3
4
Initial
Funding
Low Barriers to Entry
Startup Example
$21,195.14
Typical Expenses
20%
Compensation
Infrastructure
HR
Client
Development
Other
Income
40%
60%
80%
100%
50%
18%
13%
3%
8%
7%
Source: Charles Schwab & Co.
Helpful Hints
• Carving out from an existing firm
– Existing track record
– Expertise
– Relationships
• Initial Accounts or Partners
– Breakeven is an easier hurdle
– Existing investors make it easy to attract
more investors
1
EMERGING MANAGER INTRODUCTION
2
EMERGING MANAGER FORMATION
3
EVALUATING EMERGING MANAGERS
4
WHAT NEEDS TO CHANGE
The Check Boxes
Prospective Institutions May Require:
 A Multi-Year Track Record
 A Limit on % of Strategy/Fund Assets
 Expensive Infrastructure
 Transparency
 Prior History of Investment Team
Institutional Hurdles
Fewer/Better Check Boxes
• Investors with EM-friendly Due Diligence:
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–
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–
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High Net-Worth Individuals
Family Offices
Specialty Fund of Funds
Some Foundations and Endowments
Specialty Institutions
Due Diligence for EMs
• The Key Determinants for Success:
– People
– Philosophy
– Process
– Historical Performance (if relevant)
People
• Key Members of the team:
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–
–
–
–
–
–
History
Personality
How they work together
Drive and motivation
Intelligence
Investment Skill
Integrity
Philosophy
• Value vs. Growth
• Efficient vs. Inefficient
• Macro
Process
• Source of your investment edge
• Is it repeatable?
Performance
The Potential for
Outperformance is
Everything
One-on-One Meetings
• Nearly all Prospective Investors
Require One-on-Ones
• Meetings Usually Cover:
–
–
–
–
–
History of the Firm
Bios on Key Team Members
Investment Approach
Sample Ideas/Investments
Strategy/Fund Structure
Emerging Manager Fees
• They are dependent on:
– Niche
– Optimal Asset Base
– Return Potential
• EMs should not need to excessively
discount if capacity is limited
Chicken and Egg Problem
Emerging
Managers
Institutional
Due Diligence
AUM Hurdles
Agency Issues
Agency Issues
Institutions want to avoid being:
• More than 10% of strategy AUM
• Alone in their allocation
Social Proof
• Wrong about their decision
Maverick Risk
Agency Issues
1
EMERGING MANAGER INTRODUCTION
2
EMERGING MANAGER FORMATION
3
EVALUATING EMERGING MANAGERS
4
WHAT NEEDS TO CHANGE
Due Diligence Must…
• Remove Barriers to EM Allocations
– Length of performance track record
– AUM restrictions
• Focus on Qualitative Due Diligence
– People
– Philosophy
– Process
• Be Proactive and Constructive
The Big Get Bigger
Market Share
By AUM
2001
75%
Top 30
Firms
2009
Top 18
Firms
25%
$95B to $1.6T
$215B to $3.3T
All Other Firms
All Other Firms
Source: Northern Trust Global Advisors
Benefits of More EMs
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•
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•
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Less “too big to fail”
More experimentation
Better institutional performance
More diversity
More industry jobs
In Summary
• To BE an Emerging Manager
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–
–
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Be an entrepreneur
Get to know your prospective clients
Have a strategy that fits
Work your ass off
• To HIRE an Emerging Manager
– Get rid of the impediments for funding
– Seek out People, Philosophy, Process
– Work your ass off
Thank You
Brian T. Bares, CFA