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LPs: Emerging managers offer passion, risk: UPDATED WITH VIDEO

  • LPs see young firms as eager to prove themselves
  • Clarity on track record prior to new fund remains key
  • Younger funds may outperform later-stage funds

“Emerging managers tend to have a hunger,” Lorraine Corlet, an associate at advisory firm Franklin Park, said during a panel discussion at the PartnerConnect Midwest 2014 conference in Chicago (see related video here). “They have a strategy and they want to prove it…There’s more of that passion.”

While emerging managers may be seen as a long shot for some LPs that avoid first- and second-time funds, a study by Cambridge Associates showed that early-stage funds often turn in better performances than Fund III or Fund IV for many general partners.

“They know they come at a disadvantage to a buyout group that has a brand and a team…and a well-defined sourcing engine,” Corlet said. “But they’ll look for ways to establish themselves.”

Michael Flood, managing director at fund-of-funds manager Northleaf Capital Partners, said young funds offer great opportunities with the right manager and the right teams.

“There’s an intensity in the first fund that can drive good performance, but there is a lot of risk,” Flood said. “You have to spend more time on the way in (on research).”

Corlet and Flood said their firms don’t run a focused sourcing program for emerging managers, but they hear about them from other GPs and LPs and are open to meeting with them.

Flood said it’s important to offer a clear track record, the right fund size, team interaction and “how the economics work between everybody.”

Corlet said much of the investment decision hinges on meeting with team members and getting to know them. In one case, a fund had a former chief executive officer on its staff and didn’t even mention the person had already handled dozens of merger deals until much later in the interview.

“Keep your pitch to the point. Be clear and concise,” she said. “Bring in previous relevant experience.”

Daniel Heidenreich, principal at fund-of-funds manager Hauser Private Equity, said his firm is “always looking for the next hot manager” but added it could take years to establish a relationship with a younger private equity firm.

He said his firm has never asked for special treatment in fees from emerging managers, but he’s noticed a trend of larger family offices negotiating fee discounts and veto rights on deals in exchange for an anchor position in a new fund.

If a younger manager didn’t have a clean break with his former firm and may not have a clear track record to show to prospective investors, Heidenreich said emerging GPs need to provide ample references to show involvement in deals.

“Take the high ground. Put it out there proactively from the start,” Heidenreich said.

The comments came June 25 during a panel, “Finding and Evaluating Breakthrough Emerging Managers,” during the conference attended by hundreds of investment pros at the Ritz-Carlton in Chicago.