By Diane Harrison
Beware the industry naysayers who proclaim hedge funds aren’t worth their salt–fees/risk/terms/etc. Sweeping generalizations may make good headlines, but they are invariably proven false by the minority that refutes them through action/statements/results/etc. Investors who take the time and effort to look under the ‘hedge fund hood’ can find real value among emerging managers who traverse the less-traveled paths of finance. Let’s take a look at five reasons why smaller managers deserve examination by investors seeking a different perspective and outcome in alternatives.
EMERGING MANAGERS AND PRE-OWNED CARS: TWINS SEPARATED AT BIRTH?
According to Edmunds, the industry’s forefront resource on automotive information, certified pre-owned (CPO) cars are popular with buyers who want to minimize the risk of buying a used car. To be a CPO car, a vehicle needs to meet specific age and mileage requirements, undergoes a thorough inspection, and, if a car passes, gets an extended limited warranty and carries a higher price than a non-CPO model. Many people feel comfortable in paying that premium because of the peace of mind a CPO program gives them. Just as with CPO vehicles, the CPO purchase process isn’t flawless. There is some level of risk involved in buying any used car, but with a CPO vehicle, it is typically lower.
Emerging managers are frequently overlooked by wary investors who tend to aggregate around the old establishment of larger hedge funds and avoid the lesser-known funds. The smaller fund managers may not even make an initial evaluation list simply by virtue of not being well-known. Yet, much like certified pre-owned cars, emerging managers have often come out of the same pool of talent that has populated the industry giants. Here are several similarities between CPOs and emerging managers.
TRAINED/BUILT IN THE SAME FACTORIES
These managers have, in large measure, graduated from the same universities, worked at the same investment banks and corporations, received the same registrations and certifications, and have performed as portfolio managers and analysts though the same market cycles as managers at the large alternatives funds. Their investment pedigree contains many common elements with one key shortcoming: lack of assets under management. This last element makes it difficult for emerging managers to secure seed capital and prospect to institutions, thereby making their ability to raise assets harder to achieve. The lack of capital should not be a referendum on the quality of their training and experience, however.
GO THROUGH A RIGOROUS INSPECTION CHECKLIST
The due diligence process for a fund manager should not vary widely for a manager with $10B or $10M under management. Both managers need to demonstrate a comprehensive and solid investment and operation structure that gives investors good reason to feel comfortable in having their money managed by them. Fund managers at any level of AUM will need to show this success in practice, although the emerging managers are often scrutinized much more closely than large players by investors new to their business. Those smaller managers passing muster may be fewer in number than the top-tier fund managers, but should be considered as qualified for investment.
VALUATION IS REFLECTIVE OF THE BRAND BACKING
The essence of value for any fund is the conviction of investors regarding the manager’s ability to perform going forward. Past performance is one indication of this ability, counter to the stock phrase disclaimer that accompanies every fund manager’s performance charts. There is value in looking to the past to see what demonstrated ability any manager has shown in their investment or analytic skill to anticipate, navigate, and execute on behalf of other people’s money. Success stories and lessons learned should be integral to any manager’s discussion of their body of experience that is shared with prospective partners.
HAVE BEEN ROAD-TESTED FOR SUCCESS
Assuming the mechanics and operational structure of administration, legal, compliance, etc. has been put in place by an emerging manager, the pedigree of acquired real-time expertise and institutional experience a manager brings to the emerging fund can convey some of the quality of investment ability that attracts investors. Failure to consider emerging managers in an initial evaluation screening simply because they are presently unable to attract institutional clients on their own is a disservice to both manager and investor. Further, with sponsored sub-manager agreements and platform programs enabling emerging managers to participate in the institutional investment arena, even small managers can provide investment value to all sizes of investors.
LOTS OF MILEAGE LEFT ON BOTH
Much like the certified pre-owned car, emerging managers who have chosen to spin out of their prior institutional portfolio management role or to form a fund based on their analytic abilities typically have a lot of mileage left on their professional life. While the shiny new window sticker may not be present any longer on these managers, it has been replaced with a deeper investment knowledge and market perspective that makes the manager a valued asset to investors with congruent objectives. A new car rolling off the showroom floor typically drops in value by 40% the moment the tires hit the pavement. Not so with the emerging manager, where acquired knowledge and experience can burnish an investment prowess to a higher level of performance in the years to come.
Diane Harrison is principal and owner of Panegyric Marketing, a strategic marketing communications firm founded in 2002 specializing in alternative assets. She has over 25 years’ of expertise in hedge fund and private equity marketing, investor relations, articles, white papers, blog posts, and other thought leadership deliverables. In 2016, Panegyric Marketing has been shortlisted for Family Wealth Report’s Outstanding Contribution to Wealth Management Thought Leadership and received AI Hedge Fund’s Outstanding Contribution to Wealth Management Thought Leadership, M&A’s Excellence in Financial Services Marketing Communications – USA, and AI’s Innovation in Alternatives 2016. A published author and speaker, Ms. Harrison’s work has appeared in many industry publications, both in print and on-line. To read more of her published work in alternatives, please visit www.scribd.com/dahhome. Contact: firstname.lastname@example.org or visit www.panegyricmarketing.com.