More than three quarters of the North American LPs surveyed by Coller Capital in its recent LP survey have committed to a first-time fund since the global financial crisis, and 56 percent extended commitments to multiple debut funds. Those findings are not surprising in the context of Coller’s 2014 survey, which indicated 70 percent of North American LPs planned to make a direct commitment to a first-time fund at some point in the next two years.
Data provider Palico recently reported that first-time managers closed on $22.4 billion through the first five months of 2015, putting new GPs on track to raise more than they have in any year since the financial crisis.
Emerging manager programs, which vary in how they define “emerging” (see sidebar), have become an increasingly important strategic component of LPs’ allocations to private equity. Several major institutions, such as the New York City Retirement System and the California Public Employees’ Retirement System, continue to expand their programs even as they cull existing relationships from their portfolios.
In August, New York City re-upped $500 million to its private equity emerging manager program, doubling down on the $425 million it set aside for the strategy upon its inception in 2012. New York City plans to invest in funds managed by women and minorities, as well as GPs raising their first, second or third fund for less than $750 million.
CalPERS recently set aside up to $500 million for commitments to emerging managers who raise their first or second fund over the next five years. The $300 billion pension allocated an additional $2 billion for GPs who graduate from CalPERS’ existing emerging manager program, which is overseen by GCM Grosvenor.
Smaller LPs have also begun to focus on small, less established managers. Arkansas Teacher Retirement System recently shifted its co-investment program to bolster relationships with new GPs. Texas Municipal Retirement System, a new LP in its own right, has also indicated it is open to taking to emerging managers.
There are plenty of reasons for limited partners to carve out a portion of their allocations for an emerging manager program. Chief among them is returns. Coller found that 91 percent of debut funds equaled or outperformed the aggregate returns generated by their LPs’ private equity portfolios, according to the report.
The relative outperformance of debut funds has been true for some time. In 2012, Buyouts published data indicating the bottom-quartile, median-quartile and top-quartile internal rates of return for debut funds (3.34 percent, 10.60 percent and 18.62 percent) surpassed comparable figures for domestic buyout funds (2.43 percent, 9.4 percent and 16.15 percent).
It ain’t easy
That isn’t to say investments in emerging managers are a sure thing. Far from it, in fact.
“We have a goal that 2 percent of our $130 billion is deployed with emerging managers, and we have not been able to achieve that,” said Teacher Retirement System of Texas Director Vaughn Brock at the Pension Bridge conference in Chicago in July. “Sometimes we find excellent investors that are managers, but sometimes they spend so much time raising capital, they fail to launch.”
Many emerging GPs lack the fundamental back-office functions commonly found within large, institutionalized firms. Not having institutional-grade accounting, auditing or legal services raises serious red flags with LPs, sources tell Buyouts. It is such a big issue that New York City helps managers develop contacts with service providers and more established GPs to strengthen back-office capabilities.
While speaking at the Pension Bridge conference, Paul Denning, of placement agent Denning & Company, said managers can’t use the “emerging” tag to lower LPs’ expectations, as that will almost certainly alienate investors. “I was at the dentist, and I’m looking at the dentist, and I’m thinking to myself: What if this dentist said he’s an emerging dentist?” Denning said.
Even so, new managers will likely continue to benefit as LPs seek to re-deploy the distributions their private equity portfolios have generated in today’s exit-friendly environment.
Sidebar: What exactly is an emerging manager?
Limited partners vary in their definition of what constitutes an emerging manager.
In New York City, an emerging manager can refer to women- and minority-owned firms, as well as firms raising less than $750 million for their first, second or third funds.
Kelly Williams, co-founder of Credit Suisse Customized Fund Investment Group and senior adviser to GCM Grosvenor, said at the Pension Bridge conference in July that “emerging manager” refers to sub-$1 billion funds for buyout strategies, and typically only Funds I and II.
In March, Teacher Retirement System of Texas Emerging Manager Program Director Cheryl Lynette Hines told Buyouts: “We have one of the most open definitions of what constitutes an emerging manager. Our requirement is that a manager have less than $2 billion in AUM. That’s it.”
The range in definitions can lead to some confusion. One GP at a decade old firm recently told Buyouts about an emerging manager conference he attended where, although his firm fit the formal criteria, whenever he gave his pitch, people asked some form of the question, “What are you doing here?”
|LPs ramp up emerging manager programs|
|California Public Employees’ Retirement System||The private equity emerging manager program was valued at $6.8 billion as of June 30, 2014.||CalPERS expects to commit up to $500 million to emerging managers between 2015 and 2020. CalPERS has committed to five funds through Grosvenor’s emerging manager program since March.||Lincoln Plaza North, 400 Q Street, Sacramento, California 95811||(800) 228-5453||www.calpers.ca.gov|
|California State Teachers’ Retirement System||Total fund: $191.4 billion as of June 30, 2015. The Proactive PE Program was valued at $1.9 billion as of April 2014.||The Private Equity Proactive Portfolio targets small, niche and emerging managers. The program is managed by Invesco, Muller & Monroe Asset Management and BAML Capital Access Funds Management.||100 Waterfront Pl, West Sacramento, California 95605||(312) 604-1400||http://www.calstrs.com/|
|Chicago Teachers’ Pension Fund||$10 billion in AUM, $105 million in commitments.||Illinois law requires pensions to consider investments in emerging managers. Muller & Monroe, ICV Partners, Hispania Capital Partners and Pharos Capital Group qualified as emerging managers in CTPF’s fund.||203 N LaSalle, Suite 2600, Chicago, Illinois 60601-1231||http://www.ctpf.org/|
|Connecticut Retirement Plans and Trust Funds||$155 million.||Connecticut Horizon Fund invests in minority or women-owned firms or businesses. The goal is for those funds to represent 2.5 percent to 5 percent of the retirement system’s total assets. JPMorgan Private Equity Group and Muller & Monroe manage the Horizon Fund.||Muller & Monroe: Andre Rice, President, 180 North Stetson Avenue, Suite 1320, Chicago, Illinois. JP Morgan: Dimiter T. Mace, 270 Park Avenue, 25th Floor, New York, New York 10017||M&M: (312) 782-7771; JPM: (212) 648-2288||http://www.ott.ct.gov/pension_cthorizonfund.html|
|FLAG Capital Management||FLAG has received $6.5 billion in capital commitments since its inception.||Although it doesn’t specifically pursue an emerging manager mandate, FLAG specializes in accessing middle and lower middle market firms that manage sub-$1 billion funds. The firm tends to focus on firms with niche expertise or focus.||1266 East Main Street, 5th Floor Stamford, Connecticut 06902||(203) 352-0440||http://www.flagcapital.com/|
|GCM Grosvenor||$48 billion AUM across its entire platform.||GCM Grosvenor is an alternative asset manager. The firm hosts a conference for small and emerging managers and manages a $200 million fund of funds for CalPERS dedicated to the strategy.||767 Fifth Avenue, 14th Floor, New York, New York 10153||(646) 362-3700||http://www.gcmlp.com/|
|Illinois Municipal Retirement Fund||$34.7 billion portfolio, including $1. billion of private equity.||The $35.6 billion Illinois Municipal Retirement Fund defines emerging managers as firms with more than $10 million, but less than $10 billion, and is owned by a female, minority or person with a disability. It keeps a list of applicable managers within its portfolio on its website.||2211 York Road Ste 400, Oak Brook, Illinois 60523-2337||(800) 275-4673||https://www.imrf.org/en/investments/minority-managers-and-brokers/minority-managers|
|Illinois State Universities Retirement System||Total fund: $17.6 billion; private equity: $970 million.||The $17.6 billion retirement system’s investment policy calls for 0-10 percent of its alternative investments to go to funds managed by minorities, women, or people with disabilities. It is currently seeking a private equity emerging manager fund of funds, per its most recent investment update.||1901 Fox Drive, Champaign, Illinois 61820||(217) 378-8800||http://www.surs.com/|
|New York City Retirement System||Total fund: $165 billion; private equity: $10 billion.||In August, the city Comptroller authorized a $500 million expansion of the PE emerging manager program. The system took three years to spend $425 million on a previous allocation to PE emerging manager program that launched in 2012||335 Adams Street, Suite 2300, Brooklyn, New York 11201-3724||(347) 643-3000||https://www.nycers.org/|
|New York State Common Retirement Fund||Total investments: $184.5 billion; private equity: $13.8 billion.||The state pension defines emerging managers as having less than $750 million AUM and no more than three prior funds. Muller & Monroe runs the emerging manager portfolio.||110 State Street, Albany, New York 12236||(518) 474-4044||http://www.osc.state.ny.us/pension/|
|Massachusetts Pension Reserves Investment Management Board||Total fund: $61.2 billion; private equity: $6.9 billion as of June 30, 2015.||The Massachussets Pension Reserves Investment Management Board actively sources emerging managers, including minority and women-owned firms.||84 State Street, Suite 250, Boston, Massachusetts 02109||(617) 946-8401||http://www.mapension.com/|
|Muller & Monroe Asset Management||N/A||Muller & Monroe specializes in new and emerging private equity managers. The firm manages capital for CalSTRS, Chicago Teachers’ Pension Fund, and Connecticut||180 North Stetson Avenue, Suite 1320, Chicago, Illinois 60601||(312) 782-7771||http://www.m2am.com/|
|Teacher Retirement System of Texas||TRS has committed $1.9 billion to emerging managers.||TRS will invest in first, second and third-time funds with the requirement that a manager have less than $2 billion in AUM. Most commonly, the funds that have an interest in developing an expertise and a competitive advantage, often in areas of the market that may be overlooked by larger firms or they may have developed unique, propriety methods or modelling techniques.||816 Congress Avenue, 13th Floor, Austin, Texas 78701||(512) 542-6400||http://www.trs.state.tx.us/|
|Teachers’ Retirement System of Illinois||Total portfolio: $44.7 billion; private equity: $5.2 billion.||The Teachers’ Retirement System of the State of Illinois dedicated $500 million to an emerging managers program that encompasses private equity, real estate, equities and fixed income. It recently awarded $50 million to hedge fund Quadratic Capital through the program||2815 West Washington, Springfield, Illinois 62702-3397||(800) 877-7896||http://trs.illinois.gov/|
|Source: Buyouts research|