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Emerging ManagersFormation and Evaluation Brian T. Bares, CFA

1 EMERGING MANAGER INTRODUCTION

EMERGING MANAGER FORMATION

EVALUATING EMERGING MANAGERS

WHAT NEEDS TO CHANGE

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What is an EM?• Emerging Managers are:

– Small (low levels of AUM)– Young (less than 5 years old)– Owner/Operators

Typical Manager LifecycleA

UM

Time

Emerging Managers

Why Emerging Managers?

Better Performance

Supporting Comments“Hedge Funds under three years of age tend to perform better than do older hedge funds without necessarily adding to the volatility of returns.”

- Lazard Asset Mgmt Study

Supporting Comments“The annualized returns of Emerging Managers stood at 9.49% compared with 7.61% for bigger peers.”-Neuberger Berman 2011 strategy

outlook

Supporting Comments“Between 1996 and 2008, funds with less than $100mm delivered 13% annually compared with 10% for funds over $500mm.”- PerTrac Financial Solutions Study

Why Better Performance?• Freed of legacy positions• Freedom to be more

concentrated• Incentive fees• Flexibility with lower AUM• Niche/innovative strategies• Focused and dedicated talent





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Breakeven

Insufficient

Recurring Fees

Sufficient

Recurring Fees

What Does It Take?

What Does it Really Take?

Optimal AUM

Manager’s Interests

Client’s Interests

Optimal AUM

Inve

stm

ent R

etur

n

AUM

1

2

3 Asset Bloat

Optimal

Fundraising1

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EM’s Time Choices

Research Fundraising

Marketing & Fundraising

Paradox of Investor Demands

Breakeven

Sufficient Recurring

Fees

EMs Need to Market• Target a receptive niche• Be proactive in raising your

profile• Market even at optimal AUM

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Real

Assets 2

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Private

Equity

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Fixed

Income

Public &

Hedge

ExamplesLong/Short EquityGlobal MacroEvent Driven

Figure Out Your “Fit”

Strategic HNW

Seed Programs

Seeders

Emerging

Manager

Specialists

Fund of Funds

Family Offices

Endowments

Foundations

High Net Worth

Direct Investors

Our Story

One-on-Ones are Critical

Outsourcing Fundraising• Third Party Marketers

• Can Be Expensive• EM must still “close”• Personality must fit

• Prime Broker/Capital Introduction• Wholesale Relationships

Remember: Institutions rarely invest without meeting the investment

decision makers

Insourcing Fundraising• Inside Salesperson

• Captive 3rd-party marketing• Closer to the investment process• Expensive

Investors will still require one-on-ones with the decision makers

Informa

Morningstar

Manager

eVestment

Database entry is time consuming but worthwhile

Lipper

BarclayHedgeConsultants

Databases

1 2 3 4

Registration Service Providers Hire Team

Initial Funding

Emerging Manager

Low Barriers to Entry

New Manager Formation

$21,195.14

Startup Example

50%

18%

13%

3%

8%

7%

Compensation

Infrastructure

HR

Client

DevelopmentOther

Income

20% 40% 60% 80% 100%

Source: Charles Schwab & Co.

Typical Expenses

• Carving out from an existing firm– Existing track record– Expertise– Relationships

• Initial Accounts or Partners– Breakeven is an easier hurdle– Existing investors make it easy to

attract more investors

Helpful Hints





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The Check BoxesProspective Institutions May

Require:

A Multi-Year Track Record A Limit on % of Strategy/Fund

Assets Expensive Infrastructure Transparency Prior History of Investment Team

Institutional Hurdles

Fewer/Better Check Boxes• Investors with EM-friendly Due

Diligence:– High Net-Worth Individuals– Family Offices– Specialty Fund of Funds– Some Foundations and Endowments– Specialty Institutions

Due Diligence for EMs• The Key Determinants for

Success:

– People– Philosophy– Process

– Historical Performance (if relevant)

People• Key Members of the team:

– History– Personality– How they work together– Drive and motivation– Intelligence– Investment Skill– Integrity

Philosophy• Value vs. Growth• Efficient vs. Inefficient• Macro

Process• Source of your investment edge• Is it repeatable?

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The Potential for Outperformance is

Everything

Performance

One-on-One Meetings• Nearly all Prospective Investors

Require One-on-Ones• Meetings Usually Cover:

– History of the Firm– Bios on Key Team Members– Investment Approach– Sample Ideas/Investments– Strategy/Fund Structure

Emerging Manager Fees• They are dependent on:

– Niche– Optimal Asset Base– Return Potential

• EMs should not need to excessively discount if capacity is limited

Emerging

Managers

AUM Hurdles

Agency Issues

Institutional

Due Diligence

Chicken and Egg Problem

• More than 10% of strategy AUM

• Alone in their allocation Social Proof

• Wrong about their decision Maverick Risk

Agency IssuesInstitutions want to avoid being:

Agency Issues





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Due Diligence Must…• Remove Barriers to EM

Allocations– Length of performance track record– AUM restrictions

• Focus on Qualitative Due Diligence– People– Philosophy– Process

• Be Proactive and Constructive

The Big Get Bigger

2001 2009

Top 30 Firms

Top 18 Firms

All Other Firms

$95B to $1.6T

Market ShareBy AUM

75%

25%

All Other Firms

$215B to $3.3T

Source: Northern Trust Global Advisors

Benefits of More EMs• Less “too big to fail”• More experimentation• Better institutional performance• More diversity• More industry jobs

In Summary• To BE an Emerging Manager

– Be an entrepreneur– Get to know your prospective

clients– Have a strategy that fits– Work your ass off

• To HIRE an Emerging Manager– Get rid of the impediments for

funding– Seek out People, Philosophy,

Process– Work your ass off

Thank YouBrian T. Bares, CFA