Jogia and Brian Altenburg
By Brian Altenburg and Dipak Jogia
The topic of investing in emerging managers
receives considerable attention from investors. While
allocators increasingly talk about the need to find the next
generation of investment talent, the largest firms have
continued to attract the majority of capital flows since 2008.
This can in part be attributed to a "flight to safety"
phenomenon based on long-term track records, brand, and
business and operational stability of established firms. In our
view, this trend is likely to persist given that it is hard for
allocators to invest with newer managers without an audited
Making a judgment on an investment team with either
a short or no verifiable track record is a major analytical
challenge for the vast majority of allocators. Furthermore,
there is increased operational and business risk in allocating
to emerging managers, and also career risk considerations on
the part of the allocator. To successfully invest with emerging
managers requires significant experience in sourcing from an
opaque universe, combined with the ability to take a
forward-looking view and make decisions with limited
Investing with emerging managers can be part of a
much larger and fundamental objective of increasing the
probability of investment success combined with the alignment
of interests with the investment manager. We believe that
investment teams earlier in their life cycle and smaller in
terms of assets under management tend to outperform their
older, larger counterparts, as well as provide greater
transparency and access. In addition, hedge funds have life
cycles and the alignment of interest with investors may
decrease as investment managers scale assets and products,
diverting some of their focus away from investment returns.
Ultimately investors are making a call on human
capital regardless of the tenure of the track record. There are
a number of criteria that allocators should focus on in their
investment process when evaluating emerging hedge fund
Pedigree and Experience: Beyond
the Brand Name
Despite the fact that there are approximately
10,000 hedge funds globally, the number of investment managers
that can generate alpha remains scarce. The majority of active
managers do not add value, a useful fact that can serve to
reduce a considerable amount of white noise in the sourcing and
due-diligence process and focus efforts on the most compelling
opportunities. In our view, investment managers should be
executing investment approaches which are difficult to
replicate successfully by allocators and require an investment
team with a distinct skill set.
In our view there is no substitute for experience
and being trained by top-tier investment talent. It is critical
to understand portfolio managers’ experience at
their previous firms and how this experience frames their
investment philosophy and strategy.
Allocators need to determine whether a portfolio
manager’s prior firm employed a specialized,
alpha-driven investment strategy with the ability to generate
consistent investment returns over market cycles. The
due-diligence process should focus on the attributes that
resulted in the success of the portfolio manager’s
prior firm. Was success driven by the firm’s
culture or was the portfolio manager simply in the right place
at the right time? Is the portfolio manager talented regardless
of the environment?
Allocators should aim to invest with emerging
managers with both significant and relevant experience as a
portfolio manager or senior analyst with tenure and influence
over portfolio decisions. In the manager selection process,
there is no substitute for spending time with an investment
team to understand their experience combined with using an
established network of industry contacts to both verify and
clarify the portfolio manager’s experience and
responsibilities at their previous firms.
Allocators should verify that emerging investment
managers are highly disciplined and have a strong process
orientation. A process driven approach in our view is likely to
result in a repeatable and scalable investment strategy.
Furthermore, while allocators aim to find a discernable "edge,"
investment success is also driven by effectively executing on
basic investment functions. While having the attributes of
creativity and imagination and the ability to think in
non-linear terms is important, these attributes ultimately have
to be combined with a clearly defined investment process.
We believe that investment managers that have been
successful over a meaningful period of time all share the
hallmarks of being disciplined risk managers and have an
appreciation for "staying in the game." An emerging manager
should have a clearly defined risk management philosophy and
framework consistent with the investment strategy. While it is
hard to forecast returns with a high degree of confidence,
investment managers can have a strategy to control both the
nature and the level of risk within their portfolios and have a
pre-defined plan on how to manage position and portfolio level
exposures in the event of a drawdown. In the post-2008 world,
investment success for emerging managers is a combination of
strong security selection and disciplined risk management.
A key ingredient of success for emerging managers
is the creation of a direct alignment of interest by investing
the majority of their net worth alongside limited partners.
Investors in large, established firms often lose contact with
the key investment decision-makers over time and have limited
transparency into portfolio positioning. In contrast, emerging
and capacity-controlled managers may be more willing to engage
in direct communication with investors about portfolio
positioning and their business, and are potentially more likely
to provide a meaningful level of portfolio transparency.
Additionally, emerging investment managers may be more likely
to negotiate on the reduction of management and incentive fees,
which provides increased alpha to investment returns.
In summary, by investing in emerging managers
allocators are implementing a forward-looking investment
approach. It is ultimately a lonely endeavor since the approach
typically lacks the safety and comfort of investing in managers
with a multi-year track record, but may provide an opportunity
to potentially outperform a portfolio of established
Brian Altenburg and Dipak Jogia are
co-heads and managing directors of the Alternative Investments
Group at Oppenheimer Asset Management, an affiliate of
Oppenheimer & Co.