Emerging and Diverse Manager Programs: Worth Doing Well

August 5, 2019 |
4 minute read
|

Michael Rowland is the Commonfund Institute Summer Intern.  He is a rising senior at Case Western Reserve University. He is majoring in Finance and Accounting. 

What are Diverse and Emerging Manager Programs?

In order to adequately and fairly evaluate the success of emerging and diverse manager programs, the term ‘emerging manager’ needs to be clearly differentiated from ‘diverse manager’. While there is no formal definition, ‘emerging manager’ refers to a firm with a cap on assets under management. This cap varies widely depending on the investing organization, but usually sits around the $1 billion mark. By contrast, ‘diverse manager’ generally refers to any minority- or women-owned firm. Given these distinctions, a diverse manager is not necessarily emerging, and an emerging manager is not necessarily defined by race, gender, or any other characteristic other than being a smaller fund seeking opportunities to grow. Although diverse managers can, and are oftentimes, identified as emerging given their fund sizes, the interchangeability of these terms obfuscates the implementation and evaluation of their success.

Do Emerging and Diverse Manager Programs Improve Performance?

Considerable evidence exists that emerging managers generate higher returns. Studies show that there is significant alpha generation in the early stages of firm size, dubbed the ‘small firm effect.’1

A plethora of historical data affirms this correlation. According to a study conducted by Prequin, “emerging funds (less than three years old) earned an average of 12.2% versus the overall hedge fund industry’s return of 7.7% annually over a recent five-year time-frame (as of May 2017).”2,3

This outperformance is thought by many to be the result of two potential advantages. First, emerging manager’s small size may allow them to be much nimbler, enabling them to respond much more efficiently to market changes as compared to their larger counterparts. Second, emerging funds may be able to tap into market niches, which could allow them to exploit market inefficiencies. This precedent of emerging managers outperforming established funds drives a lot of the conversation advocating for emerging manager investments.

Contrarily, the results are much more mixed for diverse managers. Harvard Business School Professor, Josh Lerner, explores this correlation in his 2018 Diverse Asset Management Firm Assessment. In his analysis of mutual funds, Lerner concludes that “the performance of funds managed by diverse-owned firms is statistically no different than the performance of funds managed by non-diverse firms.”4

Lerner comes to a similar conclusion for hedge funds, stating that “we find no conclusive evidence that the performance of diverse-owned hedge funds differ significantly from the performance of non-diverse funds,” and comes to the same conclusion for private equity and real estate firms; “Among PE asset managers, we find little evidence that women- or minority-ownership impacts fund returns.” The evidence suggests that diverse managers are in-line with broader industry averages.

While no statistically significant excess returns may be generated from diverse manager programs, that does not diminish their importance. In his study, Lerner also explores the capital disparity among women and minorities in the field of asset management. For mutual funds, while women represent 9.9 percent of firms, they only manage 0.8 percent of industry assets. The disparity is even higher for minorities, who represent 8.8 percent of firms, but manage a mere 0.4 percent of industry assets. These disparities exist in every asset class Lerner explores, including hedge funds, private equity funds, venture capital funds, and real estate funds.

The field of finance is known for its homogenous, white male demographics. Only in the past two decades have considerable efforts been made in the fields of diversity and inclusion. As such, one of the largest inequalities facing the industry is capital allocation. Contributing capital to these underrepresented and underfunded groups will help close the disparity seen in asset management’s capital allocation, creating a more equitable industry.

What Challenges Face Diverse  and emerging Manager Programs?

Some organizations have seen great success from emerging manager programs while others have reported less than satisfactory results. One of the largest pitfalls of creating an emerging and diverse manager program is falling victim to adverse selection; creating restrictions that limit the type of potential money managers and severely decreasing the pool of managers. For example, one problematic restriction for institutions is narrowing the geography of potential managers to a particular state or region. This restriction is incredibly limiting to smaller states, especially in regions where financial services is not as prevalent an industry or where there is a limited supply of managers across asset classes. This requirement severely limits the number of potential managers and can lead to subpar returns. It is imperative that the parameters surrounding the program be flexible to mitigate potential issues. Some institutions have been so hindered by restrictive guidelines that they had to either cancel or restructure their program. Other organizations, who have been wary of this threat, realize great success from flexible, well-structured emerging and diverse manager programs.

How Can Organizations Create Effective  Programs?

Emerging and diverse manager programs can be effective, but they need to be structured carefully to realize the potential benefits. The National Association of Investment Companies (NAIC), an organization dedicated to the promotion of emerging manager programs, released a 2011 best practices report detailing seven critical success factors of an emerging manager program. For a program to be successful, the organization must have:

  1. The top management commitment and support
  2. Clearly stated goal and objectives
  3. Well-structured and clear definitions of ‘emerging manager’
  4. Strong, knowledgeable leadership of the overall program
  5. An innovative and well-conceived program
  6. Experienced strategic partners with proven track records
  7. Broad outreach to the emerging manager community

For firms and funds interested in creating emerging manager programs, it is essential to explicitly define who you are targeting with your program, create a concrete implementation plan, develop fair and commensurate evaluative frameworks, and review the success and failure of various program structures accordingly. If executed correctly, emerging and diverse manager programs can certainly be worth the investment.

What is the Future of Emerging and Diverse Manager Programs?

For emerging managers, the investment management industry collectively accepts them as vehicles of excess return. There has already been a significant amount of capital flowing into these small firms.

As diversity initiatives gain more prevalence, you can expect to see more investments in diverse managers. Social inequalities continue to persist, and the investment management industry has an opportunity to make a difference in ensuring the equitable allocation of capital.

The data shows us that emerging and diverse manager programs create a larger investment opportunity set and our social justice sensibilities tell us that this is the right thing to do; both programs are worth doing, and worth doing well.

Visit our Commonfund website today to learn more about responsible investing. 

  1. https://digitalcommons.pepperdine.edu, Investment Behavior and the Small Firm Effect
  2. www.ashtonglobal.com, Why Do Emerging Managers Outperform
  3. https://docs.preqin.com , Hedge Fund Spotlight
  4. https://knight.app.box.com, 2018 Diverse Asset Management Firm Assessment
 
Michael Rowland

Author

Michael Rowland

Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

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Disclaimer

Certain information contained herein has been obtained from or is based on third-party sources and, although believed to be reliable, has not been independently verified. Such information is as of the date indicated, if indicated, may not be complete, is subject to change and has not necessarily been updated. No representation or warranty, express or implied, is or will be given by The Common Fund for Nonprofit Organizations, any of its affiliates or any of its or their affiliates, trustees, directors, officers, employees or advisers (collectively referred to herein as “Commonfund”) or any other person as to the accuracy or completeness of the information in any third-party materials. Accordingly, Commonfund shall not be liable for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on any statement in, or omission from, such third-party materials, and any such liability is expressly disclaimed.

All rights to the trademarks, copyrights, logos and other intellectual property listed herein belong to their respective owners and the use of such logos hereof does not imply an affiliation with, or endorsement by, the owners of such trademarks, copyrights, logos and other intellectual property.

To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated herein. Forecasts of experts inevitably differ. Views attributed to third-parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Market and investment views of third-parties presented herein do not necessarily reflect the views of Commonfund, any manager retained by Commonfund to manage any investments for Commonfund (each, a “Manager”) or any fund managed by any Commonfund entity (each, a “Fund”). Accordingly, the views presented herein may not be relied upon as an indication of trading intent on behalf of Commonfund, any Manager or any Fund.

Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Fund. Such statements are also not intended as recommendations by any Commonfund entity or any Commonfund employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information or statements. Past performance is not indicative of future results. For more information please refer to Important Disclosures.