Emerging Managers Due Diligence, how is it Different?

According to Preqin research, emerging PE managers offered LPs higher returns on an attractive risk-reward basis every year. Cambridge Associates also reported that emerging managers and smaller funds tend to outperform larger scale, more established funds.

What obstacles do emerging managers face?

A high-risk bias is the primary (but not the only) reason for constraints faced by emerging fund managers.

Many institutional investors have rules prohibiting them from investing in managers, that lack an institutional multi-year track record.

For many investors, making commitments into small funds represents too great an effort in comparison to their overall portfolio size, and the amount of capital they need to invest. As a result, emerging managers often cannot meet minimum check size requirements.

Investors lack the time and resources to go through numerous pitch decks with investment ideas, and instead rely on consultants to filter on their behalf. Also, given their smaller fund sizes, consultants have a modest incentive to trawl through received decks and discover exceptional emerging managers en masse.

Identifying and building relationships with institutional-quality emerging managers, first requires substantial resources to perform the extensive due diligence required to evaluate smaller investments. For many institutional investors, due diligence on transactions that might represent a smaller investment size than usual, can be costly.

So in order to make their business ‘institutionally-attractive’ emerging managers will need to invest heavily into infrastructure.

Are emerging managers assessed differently?

The techniques of fund manager due diligence are largely the same. What will vary is the emphasis placed on some of the following factors:

 Team:

• Having individuals with significant attributable track records as part of the team is essential.
• When the fund team unites for the first time, assessing the dynamic will be key to determine any potential impact on stability.
• The existence of complimentary mix of skills (investment, operational, technical etc.) as well as clear distribution of roles and responsibilities.
• Ownership and remuneration (e.g. carried interest calculations for GPs) structure for the existing team, and equally future plans, as this affects the long-term commitment to the organization.

Strategy 

• Demonstrating a clear view strategy, and the ability to explain it, is also a vital part of the assessment.
• Assessing the opportunity and whether the manager has the methods, as well as the skills to address this in the long-term.
• A key assessment point is whether the team can defend the fund strategy as value-added, and showcase the edge and relevance that investors can identify with.

Processes

• Competitively allocating sufficient resources to the main aspects of the business; investment, operations and investor relations, for both existing and future requirements.
• Ability to manage and adjust working capital needs based on multiple outcomes and AUM fluctuation scenarios.
• Having a clear and structured process to send prompt and accurate reporting to investors.

Closer scrutiny of emerging managers can reap big rewards

While emerging managers may lack AUM size, track record, and budget of an already established asset manager – their advantages, for which they are often sought, are agility, potential and a high team drive.

Performing due diligence on an emerging manager requires similar analysis to any other fund due diligence. However, the difference is in several key qualitative factors that are more difficult to judge.

Although the task is more difficult, it also has the potential to be far more rewarding.

At Dasseti we help investors more efficiently review and analyze emerging managers utilizing our advanced  due diligence software solution. We enable investors to review more managers while doing deeper due diligence. If you would like to accurately and objectively assess emerging managers, check on our fund manager due diligence solution. For more information please contact us.