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Callan

Investments
Institute

DECEMBER 2014

Ask the
Expert

Emerging Managers
Small Firms with Big Ideas

A Conversation with
Lauren Mathias, CFA,
Vice President
Interviewed by
Uvan Tseng, CFA,
Vice President

Everybody has to start somewhere, including investment managers. Even the largest
firms with broad name recognition and substantial assets were once emerging firms.
Emerging managers generally include smaller and newer investment managers, potentially with atypical ownership structures. While smaller asset pools can work against
them in some cases, it can also work in their favor, enabling them to access opportunities that larger, more established investment managers cannot.
Many U.S. institutional investors have long track records of dedicated investments with
emerging managers while others are just starting to examine the space. Emerging
manager programs are becoming more commonplace, particularly at public pension
funds, as investors recognize the potential portfolio gains that can be achieved through
investing with the diverse and entrepreneurial investment managers that make up the
emerging manager space.
Callan has long recognized the value that diversity of professionals and firm size can
bring to investment outcomes. Our founder Ed Callan was instrumental in launching
Progress Investment Management more than two decades ago. In 2010, we launched
Callan Connects to expand our universe of emerging manager and minority, women,
and disabled owned firms. In this interview, Uvan Tseng talks with Lauren Mathias,
who oversees Callan Connects, about trends and issues in the emerging manager
arena.

Uvan

What is the definition of an emerging manager and where do minority, women, and disabled, owned
firms fit into that definition?

Lauren

The definition of an emerging manager varies pretty widely throughout the industry. The most prevalent
definition is by assets under management, but investors will also often consider the length of the desired
strategys track record, ownership structure, and ethnicity of the key professionals with ownership in the firm.
In terms of the longevity of the desired strategy, less than three years is generally considered an emerging
strategy or emerging firm. Looking at firm-wide assets under management, the most common range that
Ive seen is a maximum of between $2 and $3 billion. However, this maximum could be flexible when other
factors are looked at simultaneously. For example, for our Callan Connects program, which is Callans outreach program for meeting with new emerging managers and building our research, we define emerging
managers as those with less than $3 billion in assets, but for firms that are minority, women, or disabled
owned the maximum is $10 billion. To qualify as majority minority, women, or disabled owned, the firm must
be at least 51% owned by these persons. Emerging managers can also obtain a certification verifying their
minority or women owned status, which further clarifies the definition
We use this definition because some of our large public fund clients that are dedicated to investing in the emerging manager space, as well as in minority, women, and disabled, owned firms, utilize these qualifications.

Callan Connects
We launched Callan Connects in 2010 to expand our universe of emerging managers and minority,
women, and disabled owned (MWDO) firms. We reserve one day each quarter to meet with emerging managers with less than $3 billion in assets and MWDO firms with less than $10 billion to introduce their firms to Callan. We hold meetings in major U.S. cities to minimize travel for firms in or near
these locations. Since inception, 196 firms have participated in Callan Connects.*

Uvan

What are some of the main reasons to invest in emerging managers?

Lauren The short answer is performance. Ive seen a lot of research, over multiple historical time periods, which
show smaller managers tend to outperform larger managers.
Additionally, if an investor includes minority, women, and disabled, owned firms as part of the emerging
manager definition, then the motivation might also be to further diversify their program or better represent
the beneficiaries of their fund.
Uvan

When you look at emerging managers as a group, do they outperform established managers across
the board?

Lauren Not necessarily; it often depends on the asset class. Theres not one aggregate number that says emerging
managers beat established managers. In general, smaller managers tend to outperform, but the capacity
constrained asset classes are really where they add the most value. Smaller managers have the potential to outperform more established managers because of their nimbleness. Capacity constrained asset
classes are where smaller managers have more agility when investing versus larger firms with greater
assets under management.
*A complete list of participating firms is available at www.callan.com/datatools/connects/

Uvan

Do you think investors should evaluate emerging managers differently than established managers?

Lauren

Yes, I do think that clients should evaluate emerging managers somewhat differently than established
managers.

Specific areas to consider include:


Firm structure: Its important to understand the emerging managers asset base; if its working capital,
how long will it last? If the firm already has clients, is the client base diversified? If not, do they have a
plan to grow the client base?
Key professionals and ownership: Who are the key professionals and what is their ownership in the firm?
Have they worked together a long time or are they a new group? Do they have experience in managing
a business as well investments? Emerging managers will be running the business and handling investment decisions. And lastly, how are the professionals compensatedspecifically, are they incentivized
by the success of the firm?
Resources: Its important to understand that a lot of the new emerging manager firms come from established firms where resources were simply provided for them, and now as a smaller firm they need to
establish their own. How do the key professionals divide the tasks of building and operating the business
versus the investment management? Most importantly, is there a separate compliance officer, and who
do they report to? Which functions are outsourced? Do they have insurance policies and contingency
plans in place? A lot of the things that you may not think of for established managers are really important
to consider for a newer firm.
In terms of measuring success, its important that results are commensurate with initial expectations. For
example, if the manager is implementing a large cap growth strategy, is the portfolio doing well when large
cap is doing well? When growth is doing well? Consistency in the process and the results is a good measure of success for both emerging and established managers.

MWDO Firms by Ownership Type

MWDO Firm Offerings by Broad Asset Class

Disabled 4%

Women 34%

Other 3%

Minority 62%

Asian: 28%
African American: 43%
Hispanic or Latino: 20%
Subcontinent Asian: 6%
American Indian & Alaska Native: 1%
Native Hawaiian & Pacific Islander: 1%

Alternatives 16%
Non-U.S. Fixed
Income 1%
U.S. Equity
45%

Global/Non-U.S.
Equity 17%

U.S. Fixed Income 18%

Source: Callan database

Knowledge. Experience. Integrity.

Uvan

How does performance measurement differ for emerging managers that offer private strategies? I
expect it would be more challenging given the longer-term nature of private investments requires that
the firm has a longer track record than most emerging managers to be able to measure the success.

Lauren The same qualitative questioning applies to private and public investments, but the measure of success is
going to be considered over a different time frame. Private investments require a much longer time period
to analyze consistency.
One way to deal with short-term measurement for emerging managers of private strategies is to consider
the key professionals historical track records. They may have come from larger firms, and you can look
at their previous achievements and track records to help set an expectation for potential performance at
the newer, smaller firm. If they dont have a track record from a previous firm, then a good understanding
of all the other aspects of the emerging firm and the market opportunity for their strategy will help, as well
as watching performance as the firm builds its private investment track record. Investing with emerging
managers in private asset classes generally requires accepting that there will be limited realized track
records to analyze.
Uvan

What kinds of investors typically seek out emerging managers?

Lauren

Historically a few large state pension funds and large endowments have driven interest in emerging
manager investment, but awareness and implementation continue to grow for other state pension funds,
public utilities, and other funds, as well. In fact, other types of investors are starting to take notice. The
early investors success with emerging managers has led to interest outside of the public fund space.
Corporations seeking diversification are now interested, and recently Ive seen private wealth investors
showing increased interest in utilizing emerging managers for their retail client base.

Uvan

Why has interest in emerging managers blossomed in the last few years?

Lauren

I think it has taken time for the early adoptersthe large state pension funds and endowmentsto show
the success of their investments in emerging managers. Establishing a track record of investing with
positive results has shown other investors that its an effective space in which to invest. At the end of the
day, fund sponsors need investment results; in some cases emerging managers have provided that performance edge over the more established managers.
Additionally, since the 2008 financial crisis, fund sponsors have worked to diversify their investments. Most
of that diversification has come by asset class, but many are looking at varying ownership structures or
sizes of investment firms, where emerging managers can play a role.

Uvan

What are the more popular strategies that emerging managers offer?

Lauren

Emerging managers offer basically the same strategies that a traditional established firm would offer: equities, real estate, private equity, hedge funds, etc. U.S. equity tends to be the most prevalent, followed by
some alternative asset classes, such as private equity and hedge funds. More recently, Ive seen a growing
number of product offerings for real estate and non-U.S. equity.
The one outlier in this group is fixed income, where there are fewer product options from the emerging
manager space. The established manager community is a smaller group; its a challenging asset class
to manage with little resources. I think thats why U.S. equity tends to be the most prevalentits a liquid
space with information that is accessible to many, while fixed income is a more challenging and resourceheavy process to manage when youre smaller.

Uvan

It seems like one of the biggest challenges for emerging managers is the lack of resources to be
able to build a more stable firm. Yet most prospects are not comfortable investing with them until
they become bigger and more stable. What do you think are some of the best ways for emerging
managers to get around this catch 22?

Lauren

Emerging managers that have come from the more established firms are used to working with an institutional client base. Theres the expectation that these same investors will be their first clients at this new
smaller firm. But as you mentioned, its difficult given the size of these emerging managers for institutions
to invest in these smaller firms when the mandate sizes are much larger than the smaller firms can take at
the onset. Investors also consider the business risk of asset concentration, and dont want to represent too
large a percentage of any one managers assets.
One way of getting around this catch 22 would be for the emerging managers to consider other investor
types. I mentioned earlier the interest coming from private wealth investors, so considering retail investors through that avenue, or even sub-advising opportunities, where the mandate sizes in both of these
examples are typically smaller. They also have the option of working with manager-of-manager programs
to help them get a few dollars in the door and get the ball rolling.

Uvan

Is a manager-of-managers program the most typical way for investors to access emerging managers, or do you see more direct investments?

Lauren

Investors have a couple of options. The first is direct investment with the emerging manager. This method
is sometimes challenging for large plans because the dollar amount they want to invest tends to be too
much for smaller managers to take on. To work around this issue, a large plan could create a portfolio of
several emerging managers, essentially creating an emerging manager program. This program allocates
smaller dollar amounts to multiple emerging managers. Investors that take this approach often have substantial internal resources in order to evaluate the emerging managers prior to investing with them and
manage the program over time.
Investors that dont have the resources to research, evaluate, and monitor emerging managers directly can
look to managers-of-managers for access. These firms create multi-emerging manager strategiesessentially custom portfolios for the investor. Manager-of-managers firms have the experience and the resources
to dedicate to these portfolios on behalf of the investor.

Knowledge. Experience. Integrity.

Uvan

Beyond meeting with manager-of-managers platforms and attending a Callan Connects type
program, are there any actions that you would recommend for emerging managers to market
themselves?

Lauren This is an incredible challenge for emerging managers, because the professionals that are managing the
firm have to wear multiple hats: portfolio manager, CEO, trader, marketer, etc. Its hard to find the time
to establish marketplace familiarity with the firm. Conferences are great places to meet with prospective
clients and consultants as an introduction. Several emerging manager organizations exist that help participating firms learn more about industry trends. Emerging managers can directly contact consultants, as
well. For example, Callan encourages emerging managers to attend a Callan Connects meeting, or directly
email or call someone in our research group. Emerging managers can also directly contact potential clients, as well.
Its important to understand your audience before marketing a strategy. Institutional investors and consultants are short on time, so the emerging manager needs to know exactly what they have to offer,
whether or not that strategy appeals to the institutional investor or the consultant, and package that in a
concise way.
Uvan

What do you think is the best way for emerging managers to determine whether or not that strategy
appeals to an institutional audience?

Lauren

I recommend a quick initial email or phone call to introduce the strategy. For example, an emerging manager covering international small cap might email consultants a brief introduction to the strategy. They
might reach out to a smaller consulting firm with a limited client base and discover that the consulting firm
doesnt recommend investing in international small cap to its clients. In this example, setting up a full hour
meeting about international small cap wouldnt be a good use of either parties time if thats not an asset
class that the consultant would ever recommend to their clients. A brief introductory email or phone call
could help emerging managers spend their time more efficiently, with a focus on contacts that have interest
in their product offerings.

Uvan

Id imagine that most emerging managers offer separate accounts to start off. How important do
you think it is though to be able to offer other vehicles, like commingled or mutual funds, in terms
of helping them market?

Lauren

When considering vehicles, its important for all managers to have several options. Were finding that a lot
of our clients have multiple plans that often require different vehicles. Unfortunately, that can come at a cost
for an emerging manager.
Starting out offering separate accounts is the most efficient way. Then over time, as they start to build
assets and revenues, they can consider some of the more costly options (e.g., mutual funds, collective
vehicles).

Minority, Women, and Disabled-Owned Firms


By the Numbers

$23B

Assets managed by MWDO firms for


Callan clients

228

Number of distinct portfolios managed


by minority, women, and disabled
owned firms for Callan clients

52

Number of Callan clients utilizing


MWDO firms

750+

Number of distinct investment strategies


within Callans proprietary database
managed by firms classified as MWDO

263

Number of firms classified as MWDO


in Callans database

196

Number of emerging and MWDO


firms that have participated in Callan
Connects**

96

Number of all Callan meetings with


MWDO firms in 2014*

As of September 30, 2014, unless another date is indicated.


*Through October 31, 2014. Includes MWDO meetings through Callan Connects.
**Since inception in May 2010

Uvan

You obviously meet with a lot of emerging managers. Are there any common traits that you see
among the emerging managers that have been a little more successful at maybe crossing over
to become established managers, or just the ones that have been very successful in growing
assets?

Lauren

Ive noticed a few general characteristics about firms that have made them successful: consistency, dedication, confidence, and integrity. As it pertains to emerging managers, consistency and dedication are
extremely important. Theyre going to face multiple challenges, the catch 22 you mentioned, market hiccups, or client reallocations leading to asset fluctuations. Its going to be a challenging road, but if theyre
consistent and dedicated to what theyre doing, then they have the ability to see through those hiccups and
hopefully do well in the long term.
You have to have the confidence to know that if you are consistent and dedicated that it will eventually pay
off. I say integrity because the best managers are ones that have successful long-term relationships with
their clients, and trust is an important part of it.

Knowledge. Experience. Integrity.

Uvan

As someone who frequently meets with and evaluates emerging managers, what do you look at to
assess an emerging managers dedication to staying in business in the long-term?

Lauren

I think of it from two different perspectives: qualitative and quantitative. Qualitatively, I look for an entrepreneurial spirit, excitement about investing, and confidence about their particular process and strategy. I
ask about their plans for the future in terms of growing their staff, adding a trader, marketing to a new client
base, or creating another strategy. You can tell from an emerging managers forward-looking plans (or lack
thereof) whether or not theyre dedicated to it.
Quantitatively, I look at compensation and ownership structures. Ideally the key decision makers are partners and/or majority owners, and if possible theyre also invested in their portfolio. I think you can feel
pretty confident about an emerging manager staying in business in the long term if those qualitative and
quantitative aspects align.

Uvan

Looking at investors with dedicated emerging manager programs within the total portfolio, how do
they transition a manager out of the emerging manager portfolio? Have you seen a consistent
approach, or does it really depend on the investor how or if they graduate emerging managers?

Lauren

It varies by investor, depending on whether or not they have an emerging manager program. If they like
the manager, in most cases Ive seen clients find a space for them within their general lineup. Investors
with a dedicated program essentially have a certain asset allocation earmarked for emerging managers.
If a manager within that program no longer meets that definitionthey have been successful and have
grown their business beyond the assets dictated by the emerging manager definitionthen they typically
will not be a part of the program anymore. If the fund wants to continue to invest with this manager, then
it is most common for them to move out of the emerging manager program to be classified with the rest of
the funds managers.
But if the investor doesnt have a defined emerging manager program, then there isnt necessarily a need
for graduation; the emerging manager just becomes established and perhaps is given more assets in the
overall plan.

Get Connected
There is no fee to participate in Callans database. Information about our online questionnaire can be found on our website (www.callan.com) under Manager Questionnaire.
To submit your firm to Callans Manager Database, please send the following information to
database@callan.com:
1. Full legal name of the firm and mailing address of the main office.
2. Contact information for a business/marketing individual and a database/questionnaire
individual.
3. Name of the strategy to be included in the database.
4. Strategys quarterly returns and vehicle type.
We will respond with a manager questionnaire login once you have submitted this information.

Knowledge. Experience. Integrity.

Uvan

To wrap up, any parting words of advice for emerging managers? I know it can be very challenging
and disheartening sometimes to be able to force yourself to stay dedicated given all the challenges
of operating in that space.

Lauren

Exercise patience. Ive seen successful emerging managers that can put their heads up when they need
to: go to the conferences, send emails, make folks aware of who they are. But they put their heads down
when they need to, and they outperform and deliver consistently in their process. It takes patience to do
those two things for a longer time than you necessarily want to, especially with that entrepreneurial spirit,
drive, dedication, and excitement. Its hard to have patience over time to know that when you do well, clients will come to you and the business will grow organically.
I would urge emerging managers to be consistent, dedicated, and patient, because those are the traits that
Ive seen in the most successful emerging managers.

Uvan

Good advice that we could all apply to our work! Thank you very much for your time, Lauren.

Lauren Thank you, Uvan!

Knowledge. Experience. Integrity.

Biographies
Lauren E. Mathias, CFA, is a Vice President and U.S. equity investment consultant
in Callans Global Manager Research group. Lauren is responsible for research and
analysis of U.S. equity investment managers and assists plan sponsor clients with
U.S. equity manager searches. In this role, Lauren meets regularly with investment
managers to develop an understanding of their strategies, products, investment policies and organizational structures. Lauren also oversees the Callan Connects program, launched in 2010, which enhances Callans coverage of emerging managers
and minority, women, and disabled-owned firms. Lauren is a shareholder of the firm.
Lauren joined Callans Client Report Services group as an analyst in October 2004. Prior to Callan, she
assisted an independent financial planner in preparing financial plans for individual investors.
Lauren graduated from California Polytechnic State University, San Luis Obispo in June 2004, Magna
Cum Laude with a BS in Business Administration, concentrating in Financial Management and Enterprise
Accounting with a minor in Statistics. She has earned the right to use the Chartered Financial Analyst
designation.

Uvan Tseng, CFA, is a Vice President in Callans San Francisco Fund Sponsor
Consulting office. Uvan works with a variety of fund sponsor clients including corporate defined contribution plans and corporate and public pension plans. His responsibilities include client service, investment manager reviews, performance measurement, research and continuing education, business development and coordination of
special client proposals and requests. He joined Callan in 2008 and is a shareholder
of the firm.
Prior to joining Callan, Uvan held positions as a Research Analyst/Associate Portfolio Manager at Armory
Advisors and as an Associate Portfolio Manager at Fan Asset Management. Prior to that, he was a Financial
Advisor with Morgan Stanley. Uvan began his career at Franklin Templeton in the corporate management
training program.
Uvan earned an MBA in Finance from Santa Clara University and a BA in Business Economics from the
University of California, Santa Barbara. Uvan has earned the right to use the Chartered Financial Analyst
designation and is a member of CFA Institute and the CFA Society of San Francisco.

Knowledge. Experience. Integrity.

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If you have any questions or comments, please email institute@callan.com.


About Callan Associates
Callan was founded as an employee-owned investment consulting firm in 1973. Ever since, we have empowered institutional clients with creative, customized investment solutions that are uniquely backed by
proprietary research, exclusive data, ongoing education and decision support. Today, Callan advises on
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About the Callan Investments Institute
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the institutional investment community. The Institute conducts conferences and workshops and provides
published research, surveys and newsletters. The Institute strives to present the most timely and relevant
research and education available so our clients and our associates stay abreast of important trends in the
investments industry.
2014 Callan Associates Inc.
Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to be
reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational purposes only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of this
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