For the bulk of investment allocations, institutional investors hire managers to deploy the capital in a particular strategy. The big question is: what does an LP look for in a GP? While answers vary from general to specific, a focus on communication skills, team fit and proven expertise in a niche area is a common theme throughout.
In this week's edition of Trusted Answers, we look at some institutional investors’ insights on what makes a good manager:
The biggest challenge I face in my position is choosing the right private equity teams to partner with because you are signing up for a long-term commitment. The secondary market has evolved and is an option for liquidity, but there is a cost to achieve it. As a generalist, the entire investment universe is available for consideration, and there are a lot of good firms to choose from. This is in part why we lean heavily on portfolio construction and are disciplined as to commitment pace. It sets a high bar each year because the decision to invest with a manager today impacts the capital you have available for subsequent opportunities.
I would like to think that when we are talking to managers and looking at making a commitment to a potential fund, we are really looking at the world through their lenses, giving a sense of how the world is going to be different and how they can play a part in that change and create value, as opposed to getting the timing right and calling the bottom of a commodity or calling a top of an asset class. It's pretty difficult being a consistent winner when you have to make those timing guesses.
We look for curiosity. We look for a manager who does in-depth due diligence and is able to differentiate themselves in terms of their knowledge and understanding of the investments that they hold, no matter what part of the portfolio it is.
We look for managers that are good partners. That’s something that shows up in the terms that they offer to their investors, the way that they think when they lose money, how they make that up to their investors, the transparency of the relationship.
We also tend to love managers that are looking at less efficient spaces and have really found a niche for themselves. We think it’s in some ways easier for managers to differentiate themselves in these less-trodden, less competitive spaces. It’s easier for us to diligence both the space and the manager when it’s a little bit smaller and slightly esoteric. Those are all things we tend to look for.
That’s the big question. For the bulk of our mandates, we want to identify managers who invest on a bottom-up, security-by-security basis, using a value philosophy.
...We have two specific ways to enhance the foundation’s mission through our investments work. First, we allocated $100 million dollars to emerging minority and women-owned investment management firms. We are trying to identify firms that are starting out -- people who have a solid track record and may have come from other firms and are now managing assets. So we’ve got African American-owned firms, Latino-owned firms, Asian American-owned firms and female-owned firms. These are all firms that are just starting out. It’s a very exciting portfolio with these new managers.
In addition, we have another $100 million dedicated to mission-driven investments. These investments are aligned with our mission to strengthen and create conditions that propel vulnerable children to achieve success as individuals and as contributors to the larger community and society. Investments in food, health, well-being of children, housing, job creation, education and so on.
For venture managers, it’s really about finding the right people. What I’ve found is that we have been very lucky in having great access to proven, traditional venture managers, and we’ve also had great success in some of the emerging managers that we have backed. In a number of funds, we have been an LP since fund one, and these very successful funds have been raising funds up to fund three, four and five now. They have done very well.
Given the very long-term nature of this asset class, it’s at the end of the day about finding the right people. We have been lucky in having been able to find great emerging managers and then having them trust us and come to us, in many cases very early on.
Looking back, some of our best-performing managers were in really terrible years, and it so happened that a number of them were raising their second funds. I do believe that generally, with emerging managers’ second funds, if they do it right, the second fund often turned out better than the first one, as they got their methodology honed down. A few of our great, emerging managers that raised their second funds in ’08 were multiples over their Cambridge benchmark. Now, of course, 2008 was also a terrible year for raising venture capital toward the later part of the year given the global financial crisis.
...There is no formula per se. There are a lot of qualitative and quantitative factors that we consider with all our investments. A manager’s particular investment philosophy, approach to portfolio construction, position sizing, risk management, as well as skills such as cultivating a strong culture within the firm or managing a team are all important.
...The portfolio is $11 billion in size and is invested with around 45 managers. We have maintained 45 relationships (give or take) on average over time. We don’t look at it from a number-of-funds perspective, but from a total relationship basis.
...Our average relationship across the entire portfolio is eight-and-a-half years, so we can back it up when we say we are a “long-term” investor. Not to say that decisions are not made earlier in a particular fund’s life cycle, but we intentionally look to invest with managers that we can grow with over time into large, meaningful partnerships.
Trusted Answers is a weekly series that delves into some of the most pertinent issues within institutional investing, and shares some of the insightful responses from the 40+ institutional investors we have interviewed in the past year. Take a look at some of our other Trusted Answers.