The New Paradigm for Emerging Manager Capital - an Argument for Separately Managed Accounts

EisnerAmper recently co-hosted a breakfast with JonesTrading Prime Services entitled The New Paradigm in Emerging Manager Capital. The Panel included esteemed institutional investors such as Philip Harris of Crestline Summit Equity and Patrick Campo of Titan Advisors. 
Capital raising for hedge funds since the beginning of the equity bull market (March 2009) has proven to be extremely difficult, especially in an environment where performance has been sub-par to average. For emerging managers, it has proven to be even more difficult and accessing capital from Institutional Investors poses its own increased and unique challenges. To name some concerns: is your track record portable? What is your current AUM and what percentage of your total AUM will the institutional investor account for? (And, do you want to take the risk of having one investor comprise such a large portion of the fund?) "

From an investor perspective, separately managed accounts (“SMAs”) have always been an attractive route for investments in new managers – it provides them with “TLC” – transparency, liquidity, and control.

An SMA allows an institutional investor the opportunity to allocate to top talent while maintaining control of their own balance sheet. Additionally, it can provide an opportunity to invest in a manager whose fund potentially does not fit their return needs at the current leverage amounts – for example, an investor has identified a manager whose risk management, style, track record, etc. is attractive and is returning an annualized return of 6% with low volatility. The investor can allocate to the manager through an SMA and increase the leverage to boost the return profile of that manager, therefore providing the manager access to an allocation that otherwise would not have been available if the manager was only open to direct-investment opportunities.

From a manager’s perspective, there are pros to managing an SMA.

• Leveraging the investor/better access: if an emerging manager is managing a large SMA for an institutional investor, the manager can leverage the investor as a larger client to the sell side and, in turn, receive benefits such as more corporate access, syndicate, Street research from the Prime Broker, etc.  Emerging managers typically have lower AUM levels and in turn will not have a large enough commission wallet to allocate resources to the top PBs and research coverage from the Street.  Additionally, the financing spreads for an emerging manager can be wider as compared to a larger fund competitor. The allocator for which the manager is managing the SMA likely has more relationships and a larger balance sheet which can lead to better rates for commissions and financing, thus benefitting the emerging manager. 
  Lastly, some platforms provide middle- and back-office support and technology for the emerging manager, which reduces the burden of ‘running a business’ and/or building an infrastructure for the manager. 
• Track record: One of the biggest positives to managing an SMA is the ability to have a portable track record for which the manager is entirely responsible. This is invaluable for a manager who, after two-to-three years of managing an SMA, has decided to raise a fund – the track record can be verified and used for marketing purposes.

Time Horizon:  Whether the allocation is a direct-fund investment or a separately managed account, the time horizon for the allocation does not vary. A manager should expect conversations and due diligence – both investment and operational – to take place over a minimum period of two to three months and upwards of six months. From discussions with several allocators who provide 10-to-15 allocations per year, less than 10% of the hundreds of managers they speak to annually will receive an allocation.