“It was the best of times, it was the worst of times…”
Charles Dickens could easily have been writing about launching a new investment management firm in today’s environment. Barriers to entry are higher than ever. Compliance, legal regulations, infrastructure, technology and systems, branding and marketing, distribution – all are more complex and costly now than even just five years ago. At the same time, outsourcing, emerging manager platforms, databases, the Internet, capital investors, loosening investment guidelines and constraints – all in combination make it the best time to launch a new investment firm.
The classification for emerging managers has evolved and expanded. Emerging managers today are more loosely defined as managers with track records shorter than three years and assets under management below a specified level. Different emerging manager platforms and investors set the desired assets at different levels – anywhere from below $500 million to under $3 billion. A minority- or woman-owned status may or may not be required. Numerous studies have confirmed that smaller, more nimble firms may offer an alpha advantage. As a result, investors are turning to emerging managers more in an effort to generate alpha than to meet diversity needs. The same is true in alternative asset classes where smaller managers are considered more likely to have an edge. Investments today span traditional equity and fixed income, global (developed, emerging and frontier) markets, market capitalization size, real estate, real asset, private equity, long/short and other alternatives.
Numerous Perceived Advantages
The alpha advantages of emerging firms are attributed to:
- Execution advantages and nimbleness resulting from small assets under management
- Predominant focus on one strategy (possibly with different applications or restraints)
- Tendency to have higher-conviction portfolios
- Flat management structure
- Strongly aligned interests (owners have significant financial stakes in the success of their investment approaches and firms)
- Low cost structure
- Less likely to hit liquidity constraints or cause a market impact
- Likely to be implementing industry’s current best practices
- Opportunity for equity investment in some cases
There is some sense of urgency to discovering newer, smaller firms with competitive alpha advantages before their assets grow too large and possibly erode the alpha potential.
Challenges to Emerging Managers
At the same time, newer or smaller managers face obstacles to successful growth due to:
- Short length of track record
- Lack of name recognition
- Too little assets under management or capacity constraints
- Too few clients in a strategy
- Too small of an investment team
- Short-term performance or volatility issues
- Lack of SEC registration because of size
- Resource, technology, distribution constraints
- Operational risks
- Business risks – failure to generate enough revenue to support its costs, growth and development
Opportunity from Emerging Manager Platforms/Capital Access Partners
The emerging manager platforms appeal to investors for several reasons. They are organized to provide investors access to new managers, institutional-quality due diligence, ongoing monitoring, fee negotiation and diversification. The platforms also each have distinct emerging manager criteria regarding maximum amount of assets under management, track record, and minority- or women-owned status. Emerging managers benefit from the platforms’ support in multiple areas:
- Capital access
- Business advice
- Outsourcing opportunities
- Marketing and distribution
Because there is an increasing number of emerging managers, there is a broad opportunity for early stage investors. As a result, they are leveraging their negotiation powers across such factors as liquidity terms, transparency, corporate governance, fee structure and incentive fees or a “claw-back” of the performance fee in the event a manager fails to achieve a targeted return.
Criteria for Selection
The platforms generally accept the impediments described above that are related to an emerging manager’s newness. The primary criteria expected from emerging managers, regardless of ownership status, are likely to include:
- Clearly defined business plan that documents the emerging manager’s qualifications, capital needs, fee structure, break-even points, target markets and distribution; financial strength and demonstrated sustainability for at least three to five years; significant investment alongside investors/clients; institutional-ready in terms of: compliance, operations, reporting; analytics; trading policies; business continuity/disaster recovery plan; cybersecurity
- An investment-driven firm with well-qualified, experienced people to lead investments, business management, research, trading, client service and distribution, legal and compliance, operations and administration; high-quality outsourced resources (e.g., back office, legal/compliance), where needed; adequate technology, systems and resources
- Well-articulated investment process that conveys the value proposition concisely and clearly, along with well-defined risk management disciplines; a process that is repeatable; a culture that encourages challenges to the investment premise and a commitment to continual improvement; a defined process and appropriate resources for research
- Clearly understood capacity and appropriate growth objectives
- A client service model that is relevant to the firm’s target markets
In summary, the best time to launch an investment firm is when there is talent, clear ability to add value, commitment, financial sustainability and market demand. Many firms launched post- crisis are thriving in this challenging new world, bringing much-needed high quality investment management to fulfill the needs of institutional and retail markets.
Excerpt from Charnley & Røstvold, Inc. Emerging Managers Research, 2015
By Jacqueline L. Charnley
© 2016 Charnley & Røstvold, Inc.
Charnley & Røstvold, Inc., a preeminent marketing consulting firm to asset management firms ranging in size from start-up firms to some of the world’s largest investment firms with over $1 trillion under management. Charnley & Røstvold helps clients with competitive positioning, marketing strategies, key messages, presentation refinements, communications and sales training, consultant relations and client service programs.
Jackie Charnley, co-founder of Charnley & Røstvold, Inc., is a popular industry speaker and author. Jackie serves on the ICMA-RC Board, a not-for-profit company serving the financial needs of over one million public employees. She was also a founding board member of PAICR (Professional Association for Investment Communications Resources).