I’m going to steal the first question from the title of a research paper you guys put out recently: Are emerging managers worth it?
Koenig: There’s a really strong concentration of these first-time funds in the top quartile [of PE fund performance]. Realistically, because that data has been from guys who’ve been successful enough to come back to market, you’re going to get a lot of survivorship bias.
So, does the market look like the research we publish? Probably not. The third and fourth quartile first-time funds are probably underrepresented. Anecdotally, we know a lot of the ones that come out don’t come back.
Abell: The distribution of outcomes is wider in emerging managers. You get more upside in the better firms and you get more downside in the ones that underperform.
What are some of the strategies you use to identify who will survive to come back with Fund II?
Abell: We’re looking for managers who, ideally, are folks that have worked together before. Not just that they’ve known each other, but that they’ve been partners and that they’ve made decisions together.
That’s important because it helps us get comfortable. [If] they’ve made difficult decisions together as a group, they know how to disagree with each other in a constructive way. They can give feedback and pushback that’s honest. That helps mitigate blow-up risk.
People who’ve known each other for many years, but haven’t been in a partnership together, sometimes those dynamics can lead to unexpected outcomes. It’s different being in a partnership.
Koenig: [We want] first-time funds, not first-time teams.
How has the emerging manager market changed? Is it more competitive for LPs? Is it more competitive for new GPs?
Abell: Emerging managers 10-15 years ago were often someone who came out of an investment bank, who knew an industry really well. Today, most of the emerging managers we look at — or the ones we spend time on — are ones that have track records that we can validate.
It’s definitely a more competitive environment for many of the spinouts, especially for the ones with long track records that look good, because there are a lot more people willing to do those first-time funds.
Have you guys ever anchored a new or first-time fund? Has that helped you negotiate favorable alignment of interest or economics?
Abell: We have anchored first time funds.
Koenig: But we haven’t taken GP stakes [i.e., minority ownership of a private equity firm].
Abell: We don’t take any economics from the GP. And the only negotiation of terms that we do is to generally take it down to, what I call market terms, if there are aggressive terms in there. We don’t punish the emerging manager for [us] being an early investor.
There’s no doubt that you have more leverage when you’re the first investor, to make sure those terms are there. But what we don’t do is look for a preferred position to other limited partners, even if we could do that.
In your experience, do emerging managers represent a greater population of firms that are minority or women-owned?
Abell: We’re more likely to see, when you’re meeting with first time funds, firms that have some of those characteristics.
Koenig: I still think that the average first-time fund is not a minority or women-owned fund, but there are definitely a higher number of funds that have those ownership characteristics than what you see in more mature firms.
Abell: The number of women and minority-owned vehicles that are on Fund IV is very different than the number of women and minority-owned funds that are on Fund I or II.