Demand for emerging managers has grown for both altruistic and pure profit-making goals. From a social good standpoint, publicly-held pensions and investment funds reach out to emerging fund managers and brokerages as a way of selecting managers that represent the diversity of their beneficiaries. At the same time, investors are looking to emerging managers as a way of increasing their returns. The challenge seems to be getting the funds into the hands of the emerging managers.
An increasing number of states, municipalities and other public pensions, have emerging manager mandates. Each week, Crain’s Pensions & Investments, lists new manager searches from an array of funds. In just the past few months, funds that have added or are searching for emerging managers include: New York City Pension Fund, St. Louis Employees, Illinois Investment Board and CALPERS. According to a study by KPMG (formerly Rothstein Kass), Women In Alternative Investments: A Marathon Not a Sprint, the number of funds with emerging manager mandates continues to grow; however, implementing these mandates appears to be more of a challenge.
The study notes that most funding for women-owned-and-managed funds comes from high-net-worth individuals and family offices despite growth in the number of mandates at pensions and endowments. The study’s authors comment, “while perhaps not as speedy as some would like, diversity mandates, as well as demonstrated outperformance by women managers, are driving investors to increase allocations to women-run funds. In fact, nearly 25 percent of the investors polled for this report indicated they would increase their allocations to women-owned or-managed funds in the coming year by some margin.”
Is funding a supply problem?
In its 2013 study, Women in Alternative Investments: Building Momentum in 2013 and Beyond, the study’s authors noted that of the 366 women polled, only 5% had received emerging manager funding despite the number of mandates. That number improved somewhat in 2014’s study to 8.5%, but the study did not look at the size of that funding – suggesting that funding levels may still be quite low, even at firms receiving emerging manager funding.
At the same time, the vast majority of investors surveyed, (93%) have no mandate to invest in women-owned or –managed funds. The primary reason given was “lack of supply.”
Kelly Easterling, formerly a principal at Rothstein Kass (now part of KPMG) comments in the report, “Investors and women-owned and -managed funds are faced with an interesting dilemma of which comes first, the chicken or the egg. One of the reasons that investors are not able to invest in diversity funds is the lack of diversity funds available for investment. Without a large supply of funds, it’s difficult to achieve appropriate portfolio diversification or, for that matter, put enough money to work to move the performance dial. On the other hand, until there is more money flowing to women-owned and -managed funds, it’s unlikely that there will be a stampede of new fund launches. Unfortunately, that paradox slows the process down for both sides of the equation.”
Or a structural issue?
In our view, however, a “lack of supply” is too simplistic an answer to the gap between emerging manager mandates and funding. Differences in scale seem to be one aspect of this disconnect.
Private equity/venture capital investors seem to be honing in on this opportunity. At the M&A Advisor’s 2013 Summit in December of last year, a panel of investors spoke about their interest and efforts in investing in and building emerging managers. One of the panel participants, Spiros Maliagros, President of TIG Advisors, an investment platform that oversees assets across multiple strategies, commented that investor dissatisfaction with emerging manager mandates was not really about supply but rather scale. “The issue isn’t the opportunity set, or the expanding opportunity set – there are about 2,000 managers in that subset. The issue was a function of many factors. Investors would ask, ‘How do we write appropriately sized tickets? I need to write a $100 million ticket, and these managers are only $100 million in size. How do we get a risk aggregation across disparate systems that aren’t tracked by the consultants we use? How do we source these managers?’”
A lack of marketing and client service bandwidth also hampers asset growth for emerging managers. At many small shops, the portfolio managers also handle marketing and client service – meaning they have to take time away from investing to attract new assets. Another challenge for emerging money managers is the ability to meet RFP requirements that consultants seek.
Nili Gilbert is a co-founder and portfolio manager at emerging manager, Matarin Investments. She comments,” There are several pension plans who want to hire emerging managers, but in their pension plan policy statements –often written many years ago, before Dodd Frank — are terms that require a manager to be SEC registered. With the advent of Dodd-Frank, a manager has to have over $100 million in regulatory assets under management to be allowed to try to become SEC registered. This change has thrown up another hurdle for many emerging managers which creates a chicken and egg situation with plans telling them they can’t hire them until they become SEC registered, yet unless some plans start hiring them, they are not allowed to register with the SEC. In an unintentional way, that regulation has probably limited the numbers of emerging managers.”
“When our firm was younger and smaller, we found that it was difficult to qualify for most direct emerging manager mandates due to the AUM and track record requirements. Last year, passing the $100M AUM hurdle that is required for SEC registration, and this year surpassing $200M as well as a 3-year track record in two of our strategies, seem to be having some meaningful impact on our ability to pursue more of these types of opportunities.”
While the growth of emerging managers will likely be, as the KPMG study notes, “A marathon, not a sprint,” with both altruistic and profit making motives behind the rise in emerging manager funds, the future remains a work in progress that will require conscious effort addressing the chicken vs egg conundrum to ensure growth continues.