A survey by Hedgeweek in May shows that 82% of emerging managers (<$250m) cite attracting investor flows as the single biggest challenge for emerging and start-up managers during the initial launch process
A survey by Hedgeweek in May shows that 82% of emerging managers (<$250m) cite attracting investor flows as the single biggest challenge for emerging and start-up managers during the initial launch process
Hedgeweek’s survey found that 46% of emerging managers consider the capital raising environment to be harder than this time last year.
The data shows that investors are still not allocating to these nascent funds, with 18% of managers naming a lack of established track record or industry recognition as one of the main hurdles (see Fig. 3.1).
Emerging managers have increasingly been set up by experienced and established individuals from within the industry, but this doesn’t always appear to convince investors.
“The bar has been raised across the board with emerging managers, with individuals who were already established portfolio managers leaving blue chip firms to set up their own,” notes Marlin Naidoo, global head of capital introduction, BNP Paribas.
Despite this proof of success, investors are still unsure.
“You may have someone who has a ten-year track record in a particular strategy launching by themselves. And even though you can follow the breadcrumbs of the track record, investors are still reluctant; it’s frustrating,” says Donald Pepper, Trium Capital’s co-CEO.
The problems in confidence lie with the fact that managing an individual fund is very different to working for a large fund which is already established and has credibility and security.
“When launching your own boutique, there’s an entire aspect of business management that you previously may not have been responsible for. You could be responsible for not just managing money, but also payroll, insurance and managing a wide-range of people,” observes David Shalom, director, capital introductions at BNY Mellon | Pershing.
US vs Europe
In North America, 46% of managers have found the capital raising environment to be either similar or easier than last year, in comparison to only 34% of managers based in Europe.
“In the US, people are more willing to have the courage of their convictions to recognise that it’s the same manager, with the same strategy, often with the members of the same team,” notes Pepper.
Wayne Yu, CEO and chief investment officer at BCK Capital notes that when allocators deal with newer managers, there are often concerns over track record and the ability to replicate the strategy’s success outside of the environment they were previously in.
“There are all these questions that keep people from wanting to pull that trigger,” Yu says. “Some of those newer managers are untested, and investors want to avoid the next big blow-up.”
From Naidoo’s perspective, investors are willing to take the market risk but not the business risk, and this often leads to hesitancy with investing in new managers.
“Emerging managers need to have the capital base to support a team of at least four or five people to be seen as credible and as a viable investment,” he notes.
Shalom says that investors look for three key attributes in emerging managers: the manager’s return history and previous experience; enough AuM to cover operating expenses and to manage business risks; and finally, proof of concept in the manager’s ability to generate returns and grow their AuM, so that other investors will have confidence that the firm will grow in size over time.
Opportunity
However, while reluctance may be prevalent among certain investors, others have identified the opportunities.
Travis Williamson, head of hedge fund investment due diligence and partner at Albourne, argues that emerging managers can also offer investors alternative benefits.
“Emerging managers are often sought for diversification, not just within the overall portfolio, but within the alternative sleeve of a portfolio. The immediate question is: what does this emerging manager bring to my portfolio to warrant taking the start-up risk? Often, start-up managers have brought novel approaches to ESG and implementation to the investment process,” he explains.
He adds that Albourne’s clients are increasingly demanding diversity and inclusion, ESG and protocol questionnaires, all pointing to a desire for mission-based investing as well as increased transparency.
Smaller and emerging hedge funds can outperform larger, blue-chip names, and there is demand for them.
Emerging managers have outperformed all hedge funds YTD and over the past 12 months, with emerging managers performing 4.8% better than hedge funds on average across the past three years.
Data from law firm Seward & Kissel’s 2022 Alternative Investment Allocator Survey shows that 73% of investors are investing in managers founded under two years ago (see Fig. 3.2).
Though this is a slight decrease from 80% in 2021, the interest in emerging managers remains notable.
“Innovation and fresh perspective remain highly valued in the hedge fund industry, as investors recognise that complacency leads to subpar returns, and emerging managers can bring novel approaches to their strategies,” Williamson observes.
There can also be benefits to being ‘first to fund’ and making allocations earlier in the fund launch process.
Fee structures are sometimes set up with early bird share classes, or founder share classes, in Europe to benefit investors who come in early, according to Pepper.
The Hedgeweek survey shows that 41% of emerging managers are currently offering discounted fee structures to attract investors and motivate them to invest earlier (see Fig. 3.3).
“Investor expectations have evolved to the point where emerging managers need to have a path to institutionalisation early in their lifecycle. Investors are not waiting on the sidelines for new managers to produce a three-year track record, they’re making allocations earlier in a fund’s lifecycle, and with earlier support comes accelerated expectations,” says Williamson.
According to Williamson, the motivating factors, such as guaranteeing capacity and favorable terms when the fund grows, are unchanged.
However, to be competitive, experienced early-stage investors recognise they need to pay higher fees when a fund is small.
“In the pre-formation and pre-launch phase, the competition for talent remains very high, with end investors competing with significant demand from platform funds,” Williamson adds.
Progress
The definition of emerging managers has always been fluid, but certain big pension funds have started to stretch the meaning to include diverse-owned and mission-based funds.
“On the mission-based investing side of it, there’s a huge interest from investors. Yes, they want to ensure good returns, but some now also want to achieve a mission alongside their investment,” says Shalom.
The mission can vary between investors, with US investors often prioritising Minority/Women-owned Business Enterprises (MWBE) and European investors pushing for ESG, according to Shalom.
While some consider the two to be distinct categories, Naidoo points out that minority-owned funds often fall within the two to three-year range of launch, thereby naturally falling into the emerging manager classification.
With increasing pressure from LPs, managers have started to consider this growing definition and make DE&I a priority within their funds, even if those funds aren’t necessarily diverse-owned or founded.
“The two things which have become imperative for all managers are improving inclusion and diversity characteristics of the manager teams and having a strong grasp of sustainable investing/ESG in the investment processes,” says Sara Rejal, WTW’s global head of credit.
“Emerging managers are in a good position to start their firms with these attributes which can make them attractive to institutional investors,” she adds.
Key Takeaway:
- While some emerging managers have struggled to capture investors’ attention and attract investor inflow, the Hedgeweek survey shows that emerging managers offer interesting benefits and returns to investors, after having outperformed other funds on average for the past three years.
