“Attractive investment management organizations encourage decisions directed toward creating investment returns, not toward generating fee income for the manager. Such principal-oriented advisers tend to be small, entrepreneurial, and independent,” says David F. Swenson in Pioneering Portfolio Management (and referenced here)
I love the quote above. In fact, in rereading it I’m reminded that at one point in my career (when I was leaving a venture capital job to go to graduate school), I had visions of one day returning to Wall Street to launch an emerging / developing manager program that would allow me to focus on the asset management business... with my venture capital hat on.
The idea of working with upstart asset managers to develop unique structures, strategies and indeed companies to align interests with asset owners in creative ways to build a sustainable asset management business sounds like oodles of fun. After all, it’s in these niche spaces that investors can make lots of money, while changing the very dynamics of the asset management business; in effect leveling a playing field that many have come to view as unfairly biased towards the established asset management community.
I know emerging manager programs often get a bad reputation with mainstream finance types. The latter are displeased that these emerging managers receive preferential treatment -- which is kind of funny because the very point of these programs is to disrupt the cozy, and many would say unfairly biased, treatment that large asset managers receive from pension funds due to the latter’s governance and institutional deficiencies -- but I remain a fan of these programs (or at least in the theory underpinning them). And I also think the criticism is often misplaced and thus warrants a bit of background. Here's a useful blurb from P&I:
“The term "emerging manager" goes back at least to the 1980s and often was used to describe undiscovered money managers. In the 1990s, as minority- and woman-owned firms began to open up in larger number, those firms also became classified as emerging managers... The idea was to allow new talent — particularly minority- and woman-owned firms — to gain investment mandates.”
And here’s how one asset manager describes the industry:
“Emerging Manager” conjures the energy, talent and proven alpha potential of smaller investment companies, regardless of ethnicity. The term is no longer a euphemism for “entitlement program.” Today, for many, “emerging manager” has become synonymous with “independently owned” and all the positives typically associated with employee-owned businesses — caring, originality, risk-taking, innovation and hard work by people with a real, long-term stake in their companies. Think local diner with the best food in town and a smiling owner/operator behind the counter, versus the sterile uniformity of a fast-food restaurant.” (Emphasis added)
I like that analogy. Anyway, my interests in this space seems to jive with this 2003 PCA report, which shows that emerging managers offer remarkable upside (largely because they are not burdened with the numerous problems that come with scale). And when the institutional investors take stakes in the GP or lock in preferential fees and discounts on future funds (should the emerging manager be successful), the returns can be even more attractive.
No doubt there are challenges in this space, such as identifying rising stars and putting in place the mentors that will help them grow and execute on a sustainable business model. But that’s the fun part, right?
This is venture capital... for the asset management business. And just as you need very, very savvy venture capitalists to have any hope of making money, so too do you require very smart investment professionals to identify rising stars in the emerging manager space. (Perhaps it’s wise that I stayed in academia.) Put simply, these programs have to meet risk-adjusted returns for them to be sustainable.
But I think they can.
In particular, I think if institutional investors work together in their emerging manager and seeding programs, pooling resources and knowledge to identify the rising stars, they can champion the kind of asset management business they want to see 10 years from now. It’s a no brainer.
(Which is why it’s probably already happening behind the scenes... Dramatic pause for effect.)
In sum, while certain pension funds have been unhappy with their emerging manager programs (these guys), I think there’s remarkable opportunity to make money and, in addition, shift some of the institutional biases embedded in the asset management business in favor of the asset owners.