Due Diligence for Emerging Managers: The Crucial Role of Investment Teams

Due Diligence for Emerging Managers: The Crucial Role of Investment Teams

Investing in emerging managers is akin to supporting startups in the venture capital world. It's filled with potential upside but is accompanied by increased risk. To mitigate such risk, it's paramount for allocators to engage in a rigorous due diligence process. While there are multiple facets to the due diligence process, the heart of any successful asset management firm lies with its investment team and the background of its principals.

The Background of the Team

A firm might have an impressive strategy on paper, but the individuals behind it execute it. Understanding the background of the principal team members provides a window into their ability to manage, adapt, and thrive in different market conditions. One of the first aspects to look into is the unique experience of the investment team in the proposed strategy. Generic expertise in the financial sector might not be enough. The complexities of modern financial markets require specialized knowledge.

What constitutes a "unique" experience? Emerging managers who have faced market turbulence, managed assets in specialized sectors, or navigated complex economic scenarios bring a depth of understanding that can't be easily replicated. For instance, if the strategy focuses on Asian equities, a principal who has spent a decade working in Asian markets, understanding local languages and business customs, and building networks would undeniably bring an edge to the firm's overall approach.

Team Cohesion: A Litmus Test of Synergy

It's not just individual expertise that matters. The team dynamics as a collective unit are equally critical. We've consistently observed that teams who've known each other for several years tend to showcase better synergy. There's an inherent understanding of each member's strengths, weaknesses, and working style. This understanding helps in faster decision-making, smoother conflict resolution, and efficient execution of strategies.

Moreover, teams with longstanding relationships often demonstrate a shared vision and commitment, which is integral for long-term success. Regardless of individual competencies, a disjointed team can often falter in the face of market pressures, making the longevity of relationships an essential factor in due diligence.

Track Record: Proving Worth in Real-time Scenarios

While emerging managers might not have a decades-long track record to showcase, a minimum of one to two years is vital. It gives investors a glimpse into their performance, risk management, and decision-making patterns.

It's not just about the returns, though they are significant. It's also about how those returns were achieved. Were they consistent? Were there significant drawdowns? How did the team navigate market volatility? A solid track record, even relatively short, can answer these crucial questions.

A consistent track record over such a period indicates that the investment processes are sound and sustainable. It suggests the team's ability to adapt, strategize, and execute in varying scenarios. However, dissecting this track record and understanding the underlying decisions, market conditions, and strategic shifts is crucial.

A Sustainable Investment Process

Beyond the team and their track record, understanding the sustainability of the investment process is vital. There needs to be more than just a strategy that has worked for a year or two. It needs to be one that can be sustainable over time.

To assess this, investors should understand the foundational principles of the manager's strategy. Is it based on a market anomaly that might be arbitraged away soon? Or is it based on solid value investment principles that have historically shown resilience? How does the team approach research? How are investment decisions made, and how are they reviewed? How does the team plan to source investment ideas?

A sustainable investment process should focus on attractive valuations and a disciplined approach to risk management. This helps to increase the probability that the investment strategy remains effective irrespective of market changes.

The Key Drivers of Strong Returns

Identifying potential in emerging managers requires a meticulous approach, where understanding the investment team's background and synergy becomes the cornerstone of the due diligence process. Investors should look for teams with deep-rooted experience in their proposed strategy. It's this specialization that differentiates the best-performing funds from the average ones. A seasoned team with a proven track record and a sustainable process often indicates a promising partnership for investors.