For 10 years I was partner and chief risk officer at a multi-billion-dollar fund of hedge funds, writing investment allocation tickets to alt managers large and small.
Brand name managers were mostly easy to select and fund. But the managers I really got excited about were often smaller, even emerging managers. I and my fellow investment committee members were attracted to at least some of these managers’ investment styles, strategies, and results. But in the end, we mostly couldn’t write the ticket.
It was frustrating for the investment committee and certainly was frustrating for the managers across the pre-COVID table from us. Here’s what held us back and how today’s smaller and EM managers can overcome these obstacles and get the ticket.
Sound processes not in place
Managers of every size want to leave a good mark with allocators. To accomplish this you need to prove that there are protocols and systems in place to perform recurrent tasks without overreliance on any one employee. Business risk caused us to pass over many emerging managers. This was a huge red flag because proper risk management relies on constancy: if you miss a few days of recorded portfolio data, it is like watching a new TV series from season 2, i.e. the context is gone.
Risk management was not an integral part of the investment process
If risk was an afterthought and not taken seriously, the investment committee would be reluctant to invest. If you want to pass muster here you need to demonstrate a proactive approach to risk management. By proactive I mean an approach that helps make sense of the tidal wave of data and information that is generated every day about your investment programs. It is not enough to run a granular risk report today and then shelve it. You need to demonstrate to allocators that you can use and reuse that new and historic information every day to contextualize every number. If you can’t discern what is a normal property and what is a level that would require immediate attention, the numbers are useless.
PMs didn’t invest alongside the LPs
We required, as do many others in the industry, that PMs invest a considerable amount of their liquid net worth in the funds they manage. Do the same to the extent you can. If you want others to invest in your business, they need to see you are invested as well.
Managers must use “Best of Breed” service providers
For example, Bloomberg does everything, but does not do everything well. Take a specialized approach when working with investment service providers — brokers, accounting, legal, compliance, regulatory, data management, portfolio analytics, etc. Don’t get dragged down into operational burdens by attempting to be or work with a jack of all trades. Leverage external vendors to provide the work they specialize in, allowing you to focus on what you will be hired to do – making sound investment decisions.
I remember from my allocator days, a hedge fund that had all their risk systems implemented in house. It was impressive, but was a patchwork of open source solutions. It worked because this one professional knew every line of their code. Our due diligence process took a few months and during that process, that professional left their firm. We felt reluctant to proceed with the investment on the basis of a firm with no guard rails. Moral: if you are growing and can’t dilute that risk, outsource to a best of breed provider. This decision will resonate favorably with allocators and pay back handsomely.
The future is bright for emerging managers. Whereas historically you would need to fork millions to get institutional-level infrastructure. Today, with the advent of cloud computing, machine learning and powerful visualization libraries; new technology companies are providing disruptive and accessible ways for money managers to achieve, in short order, the requirements of an institutional allocator.