Emerging Managers Formation and Evaluation Brian T. Bares, CFA

1 EMERGING MANAGER INTRODUCTION EMERGING MANAGER FORMATION EVALUATING EMERGING MANAGERS WHAT NEEDS TO CHANGE 2 3 4

What is an EM? Emerging Managers are: –Small (low levels of AUM) –Young (less than 5 years old) –Owner/Operators

Typical Manager Lifecycle AUM Time Emerging Managers

Why Emerging Managers? Better Performance

Supporting Comments “Hedge Funds under three years of age tend to perform better than do older hedge funds without necessarily adding to the volatility of returns.” - Lazard Asset Mgmt Study

Supporting Comments “The annualized returns of Emerging Managers stood at 9.49% compared with 7.61% for bigger peers.” -Neuberger Berman 2011 strategy outlook

Supporting Comments “Between 1996 and 2008, funds with less than $100mm delivered 13% annually compared with 10% for funds over $500mm.” - PerTrac Financial Solutions Study

Why Better Performance? Freed of legacy positions Freedom to be more concentrated Incentive fees Flexibility with lower AUM Niche/innovative strategies Focused and dedicated talent

1 EMERGING MANAGER INTRODUCTION EMERGING MANAGER FORMATION EVALUATING EMERGING MANAGERS WHAT NEEDS TO CHANGE 2 3 4

Breakeven Insufficient Recurring Fees Sufficient Recurring Fees What Does It Take?

What Does it Really Take? Optimal AUM Manager’s Interests Client’s Interests

Optimal AUM Investment Return AUM Asset Bloat Optimal Fundraising 1 2 3

EM’s Time Choices Research Fundraising

Marketing & Fundraising Paradox of Investor Demands Breakeven Sufficient Recurring Fees

EMs Need to Market Target a receptive niche Be proactive in raising your profile Market even at optimal AUM

1 Real Assets 2 3 Private Equity 4 Fixed Income Public & Hedge Examples Long/Short Equity Global Macro Event Driven Figure Out Your “Fit”

Strategic HNW Seed Programs Seeders Emerging Manager Specialists Fund of Funds Family Offices Endowments Foundations High Net Worth Direct Investors Our Story One-on-Ones are Critical

Outsourcing Fundraising Third Party Marketers Can Be Expensive EM must still “close” Personality must fit Prime Broker/Capital Introduction Wholesale Relationships Remember: Institutions rarely invest without meeting the investment decision makers

Insourcing Fundraising Inside Salesperson Captive 3 rd -party marketing Closer to the investment process Expensive Investors will still require one-on-ones with the decision makers

Informa Morningstar Manager eVestment Database entry is time consuming but worthwhile Lipper BarclayHedge Consultants Databases

Registration Service Providers Hire Team Initial Funding Emerging Manager Low Barriers to Entry New Manager Formation

$21, Startup Example

50% 18% 13% 3% 8% 7% Compensation Infrastructure HR Client Development Other Income 20% 40% 60%80% 100% Source: Charles Schwab & Co. Typical Expenses

Carving out from an existing firm –Existing track record –Expertise –Relationships Initial Accounts or Partners –Breakeven is an easier hurdle –Existing investors make it easy to attract more investors Helpful Hints

1 EMERGING MANAGER INTRODUCTION EMERGING MANAGER FORMATION EVALUATING EMERGING MANAGERS WHAT NEEDS TO CHANGE 2 3 4

The Check Boxes Prospective Institutions May Require:  A Multi-Year Track Record  A Limit on % of Strategy/Fund Assets  Expensive Infrastructure  Transparency  Prior History of Investment Team

Institutional Hurdles

Fewer/Better Check Boxes Investors with EM-friendly Due Diligence: –High Net-Worth Individuals –Family Offices –Specialty Fund of Funds –Some Foundations and Endowments –Specialty Institutions

Due Diligence for EMs The Key Determinants for Success: –People –Philosophy –Process –Historical Performance (if relevant)

People Key Members of the team: –History –Personality –How they work together –Drive and motivation –Intelligence –Investment Skill –Integrity

Philosophy Value vs. Growth Efficient vs. Inefficient Macro

Process Source of your investment edge Is it repeatable?

Add text title The Potential for Outperformance is Everything Performance

One-on-One Meetings Nearly all Prospective Investors Require One-on-Ones Meetings Usually Cover: –History of the Firm –Bios on Key Team Members –Investment Approach –Sample Ideas/Investments –Strategy/Fund Structure

Emerging Manager Fees They are dependent on: –Niche –Optimal Asset Base –Return Potential EMs should not need to excessively discount if capacity is limited

Emerging Managers AUM Hurdles Agency Issues Institutional Due Diligence Chicken and Egg Problem

More than 10% of strategy AUM Alone in their allocation Social Proof Wrong about their decision Maverick Risk Agency Issues Institutions want to avoid being: Agency Issues

1 EMERGING MANAGER INTRODUCTION EMERGING MANAGER FORMATION EVALUATING EMERGING MANAGERS WHAT NEEDS TO CHANGE 2 3 4

Due Diligence Must… Remove Barriers to EM Allocations –Length of performance track record –AUM restrictions Focus on Qualitative Due Diligence –People –Philosophy –Process Be Proactive and Constructive

The Big Get Bigger Top 30 Firms Top 18 Firms All Other Firms $95B to $1.6T Market Share By AUM 75% 25% All Other Firms $215B to $3.3T Source: Northern Trust Global Advisors

Benefits of More EMs Less “too big to fail” More experimentation Better institutional performance More diversity More industry jobs

In Summary To BE an Emerging Manager –Be an entrepreneur –Get to know your prospective clients –Have a strategy that fits –Work your ass off To HIRE an Emerging Manager –Get rid of the impediments for funding –Seek out People, Philosophy, Process –Work your ass off

Thank You Brian T. Bares, CFA