Discover how meticulous manager selection can unlock high-quality deal flow and access to top-tier funds in private markets.
Investing in private markets offers unique opportunities, but it also requires a meticulous approach to selecting the right managers and funds.
Unlike public markets, where investments are often guided by benchmark constraints, or passive funds, which aim to match the performance of a specific market index, private market managers typically have greater freedom in how they construct portfolios and pursue investment strategies to align with their specific objectives.
Selecting the right fund managers is crucial, not least as there can be a big difference in returns between the best and worst performers (high return dispersion).
When selecting a manager there are some key factors to take into account:
Track record
While past performance is not a definitive predictor of future success, it remains an important component of evaluating a fund manager. Scrutinising a manager’s track record involves more than just reviewing returns. For example, consider how a manager has navigated economic downturns or market volatility. Did they demonstrate resilience and adaptability?
Additionally, assess their performance across different market cycles to understand their consistency and ability to manage risk. In some cases, the track record may need to be derived from other sources, for example if it is a first-time fund by a new manager, it is necessary to consider the track record in adjacent strategies or potentially if the investment team were working elsewhere.
Investment team
Verify how stable the investment team has been. Has the Investment Committee been investing together for many years and can they stand behind the track record?
Sector, geography and industry specialism
A manager’s specialism in certain sectors, geographies, or industries can be a decisive factor. Their ability to source the best investment opportunities often hinges on their expertise and established networks within these areas.
For example, a manager with technical knowledge of renewable infrastructure has unique insights and access to opportunities not readily available to others, and would be able to secure partnerships with utilities, power offtakers and governments, at a local level.
In the context of private equity, when a manager thoroughly understands a business and can effectively communicate with its owners – particularly those who have managed the company for generations – it provides a significant advantage. This level of insight can result in more successful acquisitions and improved long-term outcomes, unlike managers who rely on superficial understanding.
This is especially true in challenging markets. For example, when liquidity in the market is scarce and merger and acquisition (M&A) activity drops, having a close relationship with an expert general partner (GP) that has insights in a certain industry can lead to better deals with lower competition and better execution.
Managers who create innovative and bespoke solutions to meet clients’ objectives can offer a competitive edge, such as customised investment strategies that align with specific client goals and risk appetites.
Operational capabilities
The operational capabilities of a fund manager can determine its effectiveness in managing investments. Assess whether the manager has the necessary infrastructure and resources to handle the complexities of the portfolio. For example, a manager with a dedicated operations team and advanced technology platforms can efficiently oversee and optimise portfolio performance. This includes the ability to drive sustainability goals, such as investing in clean energy generation.
Fee structure
Fee structures in private markets vary according to the asset class, how the fund is structured and the nature of the investment process. For example, some open-ended evergreen (or semi-liquid) funds don’t charge performance fees, but only management fees, which is the approach we take at Schroders Capital across our semi-liquid range. This arguably makes costs more transparent and means enhanced performance accrues exponentially to end investors. It also avoids any risk of paying a performance fee on unrealised gains (performance that has not been crystallised via an exit).
However, in high returning strategies there are often performance fees or a carried interest applied, either on an underlying deal basis or in relation to overall fund returns, often after a pre-defined performance threshold (hurdle or watermark) has been surpassed. Arguments in favour of this approach are that it can ensure strong alignment between the manager and the investor. It also potentially acts as an important retention mechanism for the investment team, as their incentives can be directly linked to the outcomes produced by the funds they invest. The structure of the carried interest can also vary between managers and funds and have different hurdles.
Risk management culture
Understanding a manager’s approach to risk mitigation is critical. How do they identify, assess, and manage potential risks within the portfolio? For instance, a manager may employ sophisticated risk assessment tools and stress testing to anticipate potential challenges. A robust risk management culture should be evident in their processes and the operational capabilities they have in place to manage the portfolio companies or assets effectively.
Read our full analysis on the crucial considerations for wealth managers when allocating to private markets.
Explore how Schroders can help private investors access private markets.
New to private assets? Get started with our essential 101 resource on the Schroders Capital website.
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