From Potential to Performance: Elevating Emerging Managers in a Competitive Landscape
INTRODUCTION
In the ever-evolving landscape of institutional real estate, Emerging Managers are garnering attention from Investors and Consultants for their potential to outperform larger, more established peers. Industry and academic research underscore this trend, pointing to factors like nimbleness in their investment approach, deeper founder engagement and a strong alignment of interest as key drivers behind Emerging Manager success. Yet, despite these promising indicators, many Emerging Managers struggle to attract capital from Investors and Consultants, who often gravitate toward larger, more established General Partners (GPs) due to perceived stability and reduced risk.
This blog delves into the critical challenges faced by Emerging Managers and explores actionable strategies that can enhance their appeal to institutional Investors, ultimately helping them bridge the gap between potential and performance. Join us as we unpack the common hurdles and highlight solutions from Alliance Global Advisors designed to elevate Emerging Managers in a competitive marketplace.
We thank Larissa Herczeg, Founder and Managing Partner of 1 Seed Partners and Peter Braffman, Managing Director, Real Estate Investments, at GCM Grosvenor, for their insightful contributions on this topic.
For this blog, Emerging Managers are defined as:
first-time fund sponsors such as a local or regional operator that historically capitalized deals through its high-net-worth networks or by partnering with an allocator fund
a spin-out of a team from an established manager
a later-stage Emerging Manager raising a Fund II or III
Additionally, many Investors and Consultants commonly include a Manager that manages assets below a given threshold, generally $1 to $2 billion in gross AUM, as well as Minority and Women Business Enterprises (MWBE) within the Emerging Manager definition.
Across asset classes, industry and academic research has concluded that Emerging Managers can outperform their more established, larger peers[1]. As shown in the below chart, on average, smaller size funds perform at or above the top 10 Funds, for funds with vintages from 2013 to 2018.
Potential contributing factors to Emerging Manager outperformance are investing in smaller deals with less institutional competition, deeper involvement of the founders in the fund's investment activities and greater alignment of interest as the founders’ reputation, income and net worth hinge on the success of the firm’s early funds. Peter Braffman adds, “Emerging Managers tend to operate in the less efficient and more fractured middle market, which has the potential to give them an ‘edge’ when it comes to both sourcing transactions and generating excess returns. In addition, our research has shown Emerging Managers tend to be sector specialists far more often than their larger or more mature peers; as such, Emerging Managers are also often the first institutional capital to enter more nascent asset classes.” Larissa Herczeg believes Emerging Managers face more pressure to win with each investment, mentioning, “Smaller managers are in a ‘must succeed’ situation. If they don’t generate attractive returns, they simply aren’t going to survive. In addition, because their capital is so scarce, they have to be incredibly thoughtful about each investment and portfolio construction. Every dollar moves the needle from a return perspective, so any misstep could be costly, and the opportunity cost of each dollar is also quite high.”
Source: GCM Grosvenor analysis of Preqin data
Past performance is not necessarily indicative of future results. No assurance can be given that any investment will achieve its objectives or avoid losses.
Intuitively, the potential for superior performance should be a catalyst for greater interest in Emerging Managers from Investors and Consultants. While several institutional Investors have created dedicated Emerging Manager programs, such as the Teachers Retirement System of Texas and Illinois Teachers’ Retirement System, Emerging Managers continue to face several challenges to broader implementation across the Investor and Consultant community. Investors have increasingly gravitated toward concentrating their capital with fewer GP relationships in recent years and given the smaller fund size of most Emerging Managers, this trend creates a barrier to working with specific Investors with Manager and fund concentration constraints.
Investors and Consultants have also gravitated toward more established, larger GPs that theoretically present less “headline risk or career risk” should results be suboptimal – ‘you can’t get fired for hiring Blackstone.’ “The past four years have been a difficult fundraising environment for everyone, but especially newer, smaller Managers. Investor attitudes of focusing on doing more with fewer partners, combined with a decade-plus of strong returns, have made very few slots for new firms,” states Herczeg.
Lastly, there is a perception that greater business risk associated with Emerging Managers causes the outperformance to be less appealing once considered on a risk-adjusted basis. Moreover, Investors and Consultants may not have the resources and time to vet this aspect of an Emerging Manager thoroughly.
For Emerging Managers, addressing business risks is crucial to providing Investors and Consultants the necessary comfort level to pursue committing capital. Often, across Emerging Managers, there are common issues in business management, operational policies & procedures, investment process, capital raising and client service that can be addressed to provide a similar profile relative to larger GPs. Many of the issues are derived from a lack of in-depth understanding of best practices, the competitive set and the requirements of the institutional investment community. Many Emerging Managers have difficulty meeting these requirements mentions Braffman, stating, “The biggest barrier we see is that institutional investor processes have been designed around firms who have significant resources devoted to fundraising and investor servicing. We have seen Emerging Managers struggle when it comes to raising capital from Investors which require multiple rounds of DDQs/RFPs, Consultant interviews and board discussions.”
1. Business Management
Emerging Manager leadership teams need to combine experience as a successful Investor with the added role of CEO of a growing organization. The ability to balance these two roles and avoid becoming too far removed from the firm's investment activities is critical to sustaining successful investment results. A strategic plan in areas such as adding to the team, professional development, forming a corporate culture and building appropriate infrastructure is essential to maintaining this balance.
Alliance Solutions
Given experience observing the various challenges and successes that GPs have had with scaling businesses, the Alliance Global Advisors team can provide guidance on an Emerging Managers strategic growth plan. This can include conducting a comprehensive business assessment against the competitive set to uncover strategic growth opportunities and advising on establishing the optimal organizational structure for the Investor Relations and Capital Markets teams. The ability of the Emerging Manager to paint a picture of where the firm intends to be in 5 to 10 years is essential for building greater Investor and Consultant conviction that there is potential for the relationship to scale as the Emerging Manager grows.
2. Operational Policy & Procedures
A lack of standard procedural documents, such as a succession plan, business continuity plan, valuation policy and compliance manual, which are routine for larger GPs, can make it difficult for Investors and Consultants to commit capital to an Emerging Manager confidently. This includes ESG and DEI policies, which have become a standard for many Investors.
Alliance Solutions
Given the time constraints placed on management teams of Emerging Managers with raising capital, investing and managing a growing organization, Alliance can assist in creating or reviewing these procedural documents to ensure they meet industry standards. With these documents in place, Emerging Managers will be on par with larger GPs.
3. Investment Process
Emerging Managers can appear to have a less formalized investment process relative to larger GPs. A repeatable investment process and scalable strategy are essential components of an Investor’s and Consultant's research. The ability to provide case studies that clearly illustrate the process from sourcing to value creation to disposition is critical for an Investor to be able to understand how performance will be delivered.
Emerging Managers need to be able to speak about their track record and how it relates to the current investment opportunities. If the track record is unrealized, additional data is often requested from Investors to understand the path between value creation and exit. Emerging Managers also often struggle to speak about their track record in relation to the market benchmarks that Investors and Consultants frequently use.
Additionally, articulating a philosophy for portfolio construction is essential, particularly for Emerging Managers that have historically invested on a deal-by-deal basis.
In general, the real estate industry has been slow to adapt to utilizing data analytics and technology to enhance investment decision-making. Investing in tools in this area can differentiate Emerging Managers from competitors and drive more efficient and informed decision-making for sourcing, acquisitions and asset management.
Alliance Solutions
Alliance Global Advisors would advise on formalizing and communicating the investment process and leveraging the firm’s competitive advantages that drive value creation. Investment memos are a specific area of the investment process where Emerging Managers can fall short of larger GPs. Alliance can advise an Emerging Manager on creating and structuring investment memos to ensure they’re up to industry standards. Alliance is also a resource for insight into data analytics and technology tools that are potential viable investments for Emerging Managers.
4. Capital Raising
The pitchbook, one of the first touch points with Investors and Consultants, sometimes does not look professionally done. It often leads with performance instead of making the initial focus on the team’s background, competitive advantages, investment strategy, relevant case studies and differentiators from larger GPs.
Herczeg identified the marketing materials as one of the most common areas of improvement for Emerging Managers, noting, “Many small firms are not the most polished marketers, making input and assistance from a group like Alliance very beneficial.”
Often, the terms and conditions listed in the offering documents are inconsistent with market standards. The PPM does not adequately detail the team, investment strategy and process.
At the fund launch, a data room populated with all pertinent documents for an in-depth Investor and Consultant review should be more prevalent. It demonstrates familiarity with institutional Investors' requirements; in addition to leveraging technology in the investment process, utilizing technology that allows for the efficient turnaround of due diligence materials in the formats Investors and Consultants require can provide a positive initial experience.
The pressure of raising a fund leads to Emerging Managers focusing less on developing relationships versus making a “pitch” to receive a capital commitment. Developing relationships builds Investor and Consultant comfort, leading to easier “pitches” in the future.
A lack of familiarity with the institutional Investor and Consultant community leads to Emerging Managers spending time and resources pursuing low-probability opportunities for a commitment. Understanding the priorities of various Investors and Consultants is vital.
Alliance Solutions
Provide feedback and help create a pitchbook that clearly highlights the investment strategy and differentiators that might lead an Investor to take a meeting to hear the EM’s pitch.
Advise on terms and conditions of the product offering to decrease the chance that a cursory review by an Investor or Consultant will eliminate the Emerging Manager from consideration. Alliance can help Emerging Managers be prepared for what to expect from fee negotiations with Investors and Consultants.
Provide insight into developing a data room that provides the necessary materials for an efficient in-depth review by Investors and Consultants. Alliance can inform Emerging Managers which documents are considered the most important by Investors and Consultants when reviewing a data room.
Advise on a strategy for navigating the Investor and Consultant community.
5. Client Service
The level of transparency and quality of reporting from Emerging Managers is typically inconsistent with the expectations of Investors and Consultants.
Braffman echoes this sentiment, stating, “One of the most important things for an Emerging Manager to demonstrate is control of their data. Investor requests have become more complex and increased transparency remains a theme across private market investing. Being able to report in detail on an asset-by-asset and portfolio level reflects a level of operational maturity needed to attract institutional capital.”
Post-commitment, the communication process can be less formal relative to more established, larger peers.
Alliance Solutions
Advise on reporting standards and practices and the content of quarterly reports to provide Investors and Consultants with a similar level of quality and transparency provided by larger GPs.
Advise on developing and implementing formal Investor and Consultant communications such as quarterly fund update calls and annual investor meetings.
6. Identifying Capital
One of the major challenges facing Emerging Managers is identifying the distinct pools of capital available to them, along with understanding the associated requirements and approval processes.
Many emerging operators/developers only try to access the traditional sources of capital during a fundraise.
Alliance Solutions
Alliance has a comprehensive list of the top Emerging Manager programs, detailing each Investor’s definition of an Emerging Manager, their requirements for investing with such Managers, investment focus and any known exposure to Emerging or Diverse Managers.
List also provides the contact information for each Investor and/or Consultant.
Advise on the alternative capital sources and structures available to Emerging Managers, including traditional fund sponsors or large allocators who designate a set amount of capital to emerging operators/developers.
While Emerging Managers hold the potential for superior performance in the institutional real estate arena, they face significant barriers in attracting capital from Investors and Consultants. By addressing critical challenges related to business management, operational policies, investment processes, capital raising and client service, Emerging Managers can enhance their competitive edge and align more closely with the expectations of institutional Investors. Alliance Global Advisors can offer solutions to empower Emerging Managers to showcase their unique strengths and adopt industry best practices that mitigate perceived risks, unlocking growth opportunities. If you are interested in learning more, Connect with the Alliance team.
ABOUT ALLIANCE GLOBAL ADVISORS
Alliance Global Advisors is a women-owned consulting firm focused on empowering the institutional investment community to elevate best practices. Advising clients with over $870 billion in assets under management, Alliance partners with organizations to provide an independent perspective and innovative approach to critical strategic initiatives. Our partnerships allow senior management teams to focus on what matters most: diligently managing client capital, creating value and delivering exceptional returns in a performance-driven market.
ABOUT 1 SEED PARTNERS
1 Seed Partners is a Chicago-based real estate private equity firm that focuses on the seeding and strategic capital of small, early-stage real estate Managers. Through the application of a rigorous investment process to identify best-in-class real estate investments with GP economics, 1 Seed Partners has an innovative structure that seeks to provide Investors with access to attractive small, early-stage real estate firms diversified across sectors.
ABOUT GCM GROSVENOR
GCM Grosvenor is a leading global alternative asset manager providing flexible solutions to some of the largest and most sophisticated institutional and individual Investors in the world. The firm’s platform spans Private Equity, Infrastructure, Absolute Return Strategies, Credit and Real Estate strategies. The Real Estate platform targets exposure to opportunistic middle market real estate through economically efficient structures including seed investments, joint ventures and co-investments, as well as fund investments on a primary and secondary basis.
GCM also serves as a catalyst for the Small, Emerging and Diverse Manager community. For over 30 years, the firm has developed specific expertise in funding and supporting these Managers as part of their broad investment activity across alternative investments. GCM leverages its experienced team, wide network of contacts and broad proprietary sourcing capabilities to support the Emerging Manager platform.
Disclaimer: This blog was originally published in November 2024 and will be updated periodically to reflect changes in the industry. The content may contain or cite personal and/or professional opinions that differ from the views of Alliance Global Advisors.
[1] https://www.gcmgrosvenor.com/2023/10/18/making-the-case-for-diverse-and-emerging-managers/