Risk-averse limited partners tend to gravitate to fund managers with a long track record, but are they missing out on potential upside by avoiding emerging managers?
Over the past decade, emerging managers’ share of US private market fundraising activity has declined steadily.
In 2023, this figure fell to 12.7%, the lowest share of capital raised by newer fund managers since before 2000, according to PitchBook’s recent analyst note, Establishing a Case for Emerging Managers.
Limited exits in PE and VC over the past two years have exacerbated this reality. With minimal distributions, LPs are working with smaller private market budgets to allocate to new and existing managers.
But, by allocating almost exclusively to established managers, LPs may be missing out on significant potential returns.
In VC, for example, emerging managers have outperformed established GPs since 1997, consistently producing a higher median IRR than established managers. This reflects the nature of the asset class, in which a small number of funds determine the majority of returns across venture firms.
“The average venture return is not very exciting,” said Laura Thompson, a partner at Sapphire Partners, which invests in early-stage VC funds and runs an emerging manager program for the California State Teachers’ Retirement System. “Where can you get really good returns? It’s the smaller fund sizes and emerging managers.”
This is where that risk-return scale comes in.
In a counterweight to that outperformance, a PitchBook analysis showed that returns from emerging VC managers were more volatile: While top quartile emerging funds tended to outperform, bottom and median players only marginally bested their established manager counterparts.
The new manager playbook
In traditional buyout fund investing, emerging managers are gaining traction. While established managers, propped up by decades of institutional knowledge, have historically outperformed newer managers, the “new guys” actually outperformed their seasoned peers in the last investing cycle.
Top decile buyout funds from emerging managers with vintages between 2015 and 2018 outperformed established peers by 6.6 percentage points, suggesting that emerging buyout managers may have picked up some steam over the past decade, according to PitchBook data.
The emerging managers program at the New York City retirement systems and NYC Office of the Comptroller, for example, has $9.9 billion in emerging manager commitments, the majority of which is allocated to PE. Last year, the comptroller’s office reported that the emerging managers in the systems’ private markets portfolios outperformed their respective benchmarks by nearly 5%.
A diverse portfolio
New York City’s Bureau of Asset Management sees emerging managers as a key element of a diverse portfolio, said Taffi Ayodele, director of diversity, equity, and inclusion and the emerging manager strategy at the NYC Office of the Comptroller.
Ayodele said the smaller emerging private market managers in New York’s portfolios offer access to the lower middle market and creative roll-up strategies that may not be accessible through larger firms.
“What we don’t want to do is lock ourselves out of these high-performing, differentiated strategies for the simplicity of going with the big guys,” Ayodele said.
Some of the country’s largest public pension plans are betting on the success of their emerging manager programs. In 2023, the California Public Employees’ Retirement System made a $1 billion commitment to newly established private market investors, and the Teacher Retirement System of Texas, which boasts one of the largest emerging manager programs in the country, committed $155 million to emerging PE managers last year.
At the same time, the recent boom years for private markets led to a flood of new GPs. Some might have gotten lucky—say, with a well-timed exit at the peak—while others were hurt by less fortunate timing. A major challenge for today’s LPs will be to sort out a manager’s abilities from the market’s whims.
One advantage of backing up-and-comers now is that the down market has weeded the ranks of new GPs. “The emerging managers who are fundraising now are really dedicated,” Thompson said.
James Thorne contributed reporting to this story.
Featured image by Joey Schaffer/PitchBook News
