Emerging Managers – An Emerging Manager's Perspective

Category: 

What is an Emerging Manager?

Historically, emerging meant “undiscovered”. Today, Emerging Managers can be: a) new, b) small, or c) firms that are >50% owned by women or veterans or minority or disabled employees.

Who invests with Emerging Managers?

There is an established market for Emerging Managers in the US, with a robust support infrastructure. Several investment consultancies specialize solely in Emerging Managers. Numerous databases are dedicated to capturing Emerging Manager information including one with data on over 1400 managers. Every year several conferences focus on the topic and numerous clients actively invest with Emerging Managers. In the US, the two main client groups are: 1) Family Office and Private Clients who seek the benefits of Emerging Managers (see below); and 2) pension clients who are mandated by legislation to use Emerging Managers, usually government plans at the city, county or state level.

What does the Canadian Emerging Manager scene look like?

The Emerging Manager category is less mature here than in the US. Very few new institutional asset management shops have been started in the last decade. No consulting firms, no Canadian databases and no conferences specialize in Emerging Managers. There are instances of Institutional clients hiring Emerging Managers but scant evidence of plans overtly seeking Emerging Managers as do their US compatriots. Still, there is room for Canadian Emerging Managers to be optimistic. Without a mature support system to foster Emerging Managers in this country, entrepreneurial portfolio managers are compelled to build their companies to be of high institutional quality from day one. This high hurdle may pose a challenge in the early days. However, the reward for the patient entrepreneur is to be eventually accepted as a mainstream participant in the institutional market and not as an ‘emerging’ manager.

What are the benefits of using an Emerging Manager?

Several academic studies1 have demonstrated that Emerging Managers outperform their established competitors. The chart below corroborates these studies. Using Canadian data from Global Manager Research, we show that for 82 Core Canadian Equity Managers firms with small AUM enjoyed an incremental annualized return benefit of close to 2.0% per year for ten years over larger firms. 

Chart displaying the Firm Count by AUM Bucket

Chart displaying the Average 10-year Annualized Return

The return differential is attributed to several beneficial characteristics of Emerging Managers:

  • Their small team size allows for improved communication and quick decision-making;
  • Emerging managers are nimble, able to rapidly implement new ideas and transactions;
  • Emerging managers are motivated as a) their own wealth is often invested alongside their clients’ and b) their reputations are at stake; and
  • Emerging Managers possess skill and experience.

Other benefits associated with Emerging Managers include clients having greater access to firm and portfolio decision-makers, enhanced transparency and customized reporting.

What are the perceived disadvantages of investing with an Emerging Manager?

The common worry is that Emerging Managers won’t be in business in 3 years because they:

  • Lack infrastructure to support portfolio management and administration;
  • Have employees filling multiple roles, detracting from a focus on client portfolios;
  • Lack resources (capital and people);
  • Have experience managing money not managing a business; and
  • Carry event risk. They could go bankrupt, lose key personnel, or experience a back office error.

How has 18 AM addressed these perceived disadvantages?

In 1998, when starting our last firm2, consultants told us: “we know you can manage money but can you manage a business?” This message was not lost on us. As serial entrepreneurs, we know that success in managing a business rests on a foundation of hiring good people, empowering them with clearly defined roles and goals and providing the tools needed to do their jobs.

Hiring good people – Two team members are experienced as founders and CIOs, another is a seasoned PM and the fourth, a veteran administrator. Their combined industry experience exceeds 80 years, 90% of which was gained while working together providing an experienced core. Two additional individuals strengthen the team. Hiring a recent university grad creates an employee age range of 24 to 58 years old and sows succession planning seeds. Hiring an internationally trained lawyer from a TSX 60 company to head our compliance function underscores our commitment to a capable back office. Lastly, our Advisory Board has exposure in and outside the investment industry and provides advice on governance, entrepreneurship, investment process best practice, building and managing global investment teams, fostering vibrant cultures, strategic planning and building and overseeing HR platforms.

Empowering employees with clearly defined roles and goals – Key business infrastructure is in place, such as: Corporate Vision, governance, strategic planning, financial management, client reporting, compliance procedures, investment process and a performance appraisal process. Each infrastructure item impacts employee roles and objectives. Roles and goals were clearly defined, in writing, at the time of job offer and are updated via regular performance appraisals and through the strategic planning process. A huge advantage of the entrepreneurial firm is the degree to which employees can be empowered. We lever this advantage by fostering a culture of acting big (eg. having clearly defined roles and goals) but being small (eg. lacking bureaucracy and encouraging employee inclusion).

Providing the tools needed to do the job - Examples include investing in:

  • Admin infrastructure: starting with our office but including IT, backups, disaster recovery, compliance, accounting, strategic planning, and financial reporting;
  • A world class investment process, including data, software and trade management systems; and
  • Personal development such as courses and conference attendance.

At 18 AM we have used the lessons learned in starting and running our prior shop to proactively build business and administrative processes. We do so, not only to effectively run our business but also to address perceived disadvantages of Emerging Managers. We take the stance that we haven’t lowered our standards when it comes to running the business so why should clients.

Clients and consultants are right to focus on the perceived risks of an Emerging Manager. In short, the worry is that we will not be in business in three years. Imagine then how motivated we are as owners and employees to do everything we can to ensure that your perception does not become our reality.

How could a pension plan use an Emerging Manager?

Emerging Manager benefits of added return, access and transparency have been shown in theory and in practice. Valuable due diligence resources exist, enabling clients to find capable Emerging Managers yet mitigate perceived enterprise risk. To utilize Emerging Managers in their asset mix, a pension plan should consider the use of a Core and Satellite approach:

  • Manage 70-80% of the portfolio passively or with an established Core manager;
  • Split the remainder among satellite managers, using an Emerging Managers Fund of Funds or by investing directly.

In this way, the plan receives the comfort of investing with an established manager while enjoying the benefits that Emerging Managers bring.

We are fully transparent. If you would like a copy of our business plan, please contact Jeff Brown at jeff.brown@18assetmanagement.com

 

Notes:

  1. Krum 2007, Aggarwal and Jorion 2008, Allen 2007, Newsome and Turner 2009, Beckers and Vaughan 2001, FIS Group Study on the performance drivers for emerging managers, 2007
  2. Highstreet Asset Management Inc.