Emerging funds have continually seen increased demand throughout the private finance sector. This is primarily due to the trend showing emerging managers have higher returns than more established funds. However, access to successful emerging managers has proven to be difficult. With thousands of funds launching every year, it is impractical to evaluate these managers to the same degree as larger funds. Investors need new tools to separate the quality from the noise.
Emerging managers provide access to diverse management far more often than more established funds. Though still a shortage in diversity, a report by Sutton Capital finds that within emerging manager funds in the US, women represent 14% of investment partners, while Black and Hispanic partners represented 3% each. This is valuable to have in a fund because it means more creativity, a different point of view in an investment team, and added value to the firm.
“Emerging managers naturally have a deeper focus than established funds. They have to be more thoughtful on thesis, their teams are smaller, and they have less existing commitments to manage. As a result, they can devote more time to hustling into the best deals. On the flip side, it is harder and more time-consuming to raise capital as an emerging manager.”
The hustle that emerging managers are forced to have is largely the reason why they consistently outperform more established funds. According to the study, raising capital is the biggest issue for emerging managers. According to a post by Format One, it can take 3-6 months to secure a meeting with a specific LP, and the total raise can take anywhere between 12-18 months.
An important barrier that emerging manager face is the canyon into institutional capital. They have good strategies, but they are not aware of what the institutional players are looking for, and they need support to bridge the gap. Despite this, many institutional LPs will back emerging funds with smaller checks — hoping to get access to side letters and later funds.
Many institutional sized investors tend to stick to the brand-name firms when it comes to investing in funds. Institutions likely shy away from emerging managers due to the amount of time and resources needed to evaluate a fund. Due diligence, meetings, financial audits, and strategy discussions take valuable time from LPs. However, in a study done by the Kauffman Foundation and Cambridge Associates, it has been reported that emerging managers and smaller funds tend to outperform large established funds. For many LPs, emerging funds could be worth it.