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Emerging managers often pursue innovative investment strategies that are designed to capture market inefficiencies that have not yet been recognized by other firms.
An emerging manager has traditionally been identified by its short (or non-existent) investment track record and modest assets under management. As a result, it can be difficult for institutional investors to evaluate these managers using their traditional tools, which may rely heavily on the prior track record of earlier funds.
Historically, the term “emerging manager” has been applied to minority and women-owned money management firms with less than $1 billion in assets under management. There are, however, no universally accepted definition and many public pension plans and other institutional investors have their own views on what constitutes an emerging manager and whether to limit this group to those firms controlled by historically under-represented communities.
Emerging managers often pursue innovative investment strategies that are designed to capture market inefficiencies that have not yet been recognized by other firms. Typically, these younger firms have ownership structures that provide financial incentives to all of the key participants, rather than being disproportionately held by an older generation of founding partners.
Size can be a hindrance in many funds. Although size can bring undeniable advantages, such as in terms of resources and diversification, growth can lead to diminishing returns when larger firms can lose their focus and be forced out of the sectors and transaction sizes in which they achieved their early success. Research indicates that emerging managers often perform better across asset classes, and with less risk than larger, more established firms.
Due diligence is an essential exercise for all investors to do prior to their investments in a fund. In the case of an emerging manager, the exercise is of particular importance since often these firms are at an early stage in their development and lack the staffing and infrastructure that more established firms will have had time to develop.
Further, emerging managers can operate in a number of different asset classes, such as private equity, mezzanine, real estate or hedge funds. As a result, the due diligence that a prospective investor conducts should be robust enough to consider and evaluate a wide variety of the investment objectives
Accordingly, prior to investing with an emerging manager, the following questions should be asked and answered:
• What prior history do these particular individuals have in working together on the same platform?
• Does this collection of individuals provide a complete set of those skills necessary to run a successful fund?
• If there are gaps in those skills, how does the management team propose to fill them?
• What is the team’s decision making process for determining which investments to acquire and at what price?
• If members of the investment team come with different philosophies on investing, how will these different approaches be reconciled?
• If the emerging manager is being considered because it is women- or minority-owned, will the control and economic participation of the manager be divided in such a way that reinforces such ownership or undermines it?
• Who are the emerging manager’s professional advisers and have they taken the time to analyze and adopt the most appropriate structure for the fund, given recent changes in the market?
• For each of the investment professionals, what is their individual investment history and can they provide detailed back-up to support their track record on realizations?
• Do any of the key personnel have a history with the relevant regulators or have otherwise been involved in litigation or regulatory enforcement actions?
• Is there a management oversight structure in place that will facilitate the identification and addressing of any questionable actions that may occur within the team?
An adequate evaluation of any prospective fund will necessarily include a thorough review of the fund manager and their team. In the case of an emerging manager, this review will need to be based on a wider investigation of prior firms, affiliations and platforms because the current team will have only been together for a limited time.
The view of Congress and the SEC is that sophisticated investors in private funds such as these will have the experience, knowledge and resources to conduct an adequate due diligence review. Failure to spend adequate time analyzing the risks associated with an emerging manager before investment could undermine the potenial for returns after the investment.