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Asset Alliance Hedge Harbor Navigator Emerging Managers

  • Hedgeharbor Asset Alliance Navigator Focus on Emerging Managers Conventional wisdom in the hedge fund industry-supported by much empirical evidence -suggests that emerging managers generally outperform more established managers. And yet,emerging managers still face significant impediments to raising capital compared to their larger counterparts. In this issue, we look at the case for investing in emerging managers and suggest ways to evaluate them.What is an emerging manager? have clearly outperformed mid-size and large funds. The criteria for what makes a hedge fund an emerging over the last 10 years.manager can be different for each investor. Manager Performance by Size investors would classify a manager as emerging based 180% on the age of the fund (or the management company as 160% a whole) or on the size of assets (or both). In a recent 140% publication dealing with emerging managers 1, Barclays 120% Capital defines criteria in terms of both size and age of 100% hedge funds. "Small" managers in their study are under $100 million in assets, while "new" managers have a 80%track record of less than two years. 60% 40% We agree that both size and age should be considered 20% separately when classifying emerging managers. Hedgefund managers can remain below $100 million as they 0%build their business and refine their operations. Thus,smaller emerging managers can definitely have a track Small Mid-size Large record longer than two years. At the same time, some Source: Barclays Capital and Srategic Consulting Analysis conferences that we have attended have included managers from established firms with relatively large asset levels, but with new fund vehicles. So to some The results for younger funds fit the same. pattern.extent, an emerging manager, like beauty, is in the eye of the beholder.
  • Chart 2 shows the results for managers in the three age of the beholder. categories that Barclays examines. The out performance of the category of young funds is more pronounced in The evidence for emerging manager comparison to older funds than it is for smaller out performance managers compared to larger ones.The Barclays study is typical of the empirical results regarding the performance of managers by size and by Why do emerging managers typically age. Chart 1 shows the cumulative performance of the perform better?managers in their study based on their size. Small funds The reasons that smaller and younger funds perform better are as varied as the styles and strategies that1 Source: Barclays Capital's Capital Solutions Group, Hedge they employ, but we view the reasons cited by Barclays Fund Pulse: Emerging Managers: Good Buy or Good Bye?, as being valid with some modifications.April, 2012.
  • Both small funds and young funds (which tend to have they may be more likely to devote large amounts of smaller AUMs) can capitalize on some opportunities time and energy to their performance, by, as Barclays that larger funds cannot. Smaller managers with an puts it "reacting swiftly to market up and downturns,expertise in a strategy may be better able to identify taking opportunities, but also obsessively mitigating and profit from undervaluation of small cap companies, losses."for example. The position size necessary to justify the How to incorporate emerging managers into research and monitoring of a small cap company, for a portfolio example, might expose a larger firm to liquidity or other risks in such a position. Likewise, in credit strategies, A number of considerations are relevant for investing in smaller firms may be able to participate in smaller issue emerging managers, particularly for investors who are sizes than would be profitable for a larger fund. adding emerging managers for the first time. Younger managers by definition will have shorter track records As a second reason, Barlcays notes that "some young than more established managers. This may affect the funds are newly launched products offered by analysis that investors perform to gauge the historical established fund management companies, which may risk of the manager or to compare them to the lend those funds some of the same benefits as large investor's benchmarks. Allocators should devote funds." We would add that younger funds may adopt particular attention to understanding the manager's innovative new strategies or new approaches to old strategy and method of execution in cases where thes trategies that enable them to perform better. track record is short.Chart 2: Manager Performance by Age Managers with smaller AUMs may find it necessary to 250% spend a larger portion of their fee revenues on infrastructure in order to achieve the operational200% quality necessary to satisfy institutional investors. If the manager does not focus enough on such infrastructure,150% it raises the prospects of increased operational risk for the investor. Many quality emerging managers are 100% aware of these risks and devote considerable thought and effort to mitigating these risks. An investor in 50% emerging managers should pay as much attention to operational issues as they do for established managers. 0% Hedgeharbor represents a number of funds that fall into the emerging manager category. Our team has spent a Young Mid-Age Old considerable amount of time evaluating the quality of Source: Barclays Capital and Srategic Consulting Analysis these managers and their suitability for the investors that we serve. We are happy to assist investors in identifying those emerging managers that would best fit Third, newer managers may be hungrier, so in order to into their alternative investment portfolios.achieve good performance in their critical early years.