MiddleGround Capital: Investors are getting more comfortable with emerging managers

Nearly half of capital sourced by emerging managers we surveyed was said to have come from family offices and wealthy investors, up from about 25 percent in our 2019 survey. What is drawing these investors to new managers?

Many family offices have experienced significant growth and are looking at private equity investments to seek outsized returns in their portfolios. Some have invested in staff members with private equity backgrounds to evaluate these investments. As their allocation to private equity has grown, so has their interest in emerging managers. In addition, we have seen that many family offices are run by entrepreneurs who identify with the entrepreneurial spirit of emerging managers.

More than 70 percent of managers reported receiving at least some pressure regarding fees. Are new managers going to need to reset their fee expectations in 2020?

There is a continuous dialogue between LPs and GPs with respect to fees in asset management. For an emerging manager, there are a couple of considerations. First, there is a level of fixed costs that go into running a private equity firm. Depending on the size of the inaugural fund raised, incremental fees may help an emerging manager make a strategic hire to better position them for growth or enable them to invest in a capability that will help to generate returns.

Second, many emerging managers are “active” investors, bringing specific capabilities to their portfolio companies. This level of value-add helps to support the need for the services for which some fees are charged.

Almost nine of 10 investors surveyed this year said they will back a debut PE/VC fund compared with 75 percent of respondents last year. What is driving this uptick in support for new managers?

As the private equity asset class has matured, emerging managers within the asset class have improved in quality. Many individuals have been at their respective firms for a long period of time and have demonstrated their ability to generate strong returns in those settings. However, with limited positions at the top, it drives talented investors to start their own firm.

“As the private equity asset class has matured, emerging managers within the asset class have improved in quality”

Additionally, the infrastructure around back office support has grown, enabling emerging managers to outsource some of those functions as they focus on completing transactions and hiring the team. These types of industry changes have lowered the perceived risk of the emerging manager asset class, driving more support toward it.

Despite the increase in investors that would back debut funds, willingness to make anchor commitments declined by 20 percent year on year. How can emerging managers help LPs get more comfortable with making anchor investments?

Emerging managers can help LPs get more comfortable making anchor investments by de-risking their investment. There are a few ways to approach this. First, demonstrate the pipeline is full with actionable opportunities to deploy capital. Second, offer a near-term investment in a live deal that aligns with the firm’s investment strategy. Third, have the back office infrastructure in place to support the business. And fourth, build out the team. By making these investments early on, LPs will see the conviction you have in your own strategy, helping to provide them with more comfort.