The Challenges Faced by Emerging Managers in the Private Equity Industry

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VCengine

April 6, 2023

Private Equity Investors Focused on Established Managers, Leaving Emerging Managers Struggling for Financing

The Challenges of Emerging Managers in the Private Equity Industry

Emerging managers in the private equity industry, defined as companies that manage less than $200 million in assets under management (AUM), are facing challenges in obtaining financing. Investors are now more cautious and prefer to invest in established managers under difficult fundraising circumstances. This trend is disadvantageous for new managers who usually lack an established reputation, track record, and industry connections.

As per a recent survey by Silicon Valley Bank, 83% of limited partners expressed interest in developing new relationships with managers, while only 16% were focused on investing exclusively with well-established managers. Despite this trend, emerging managers are facing significant challenges in raising funds due to their lack of industry connections and brand recognition.

Limited partners have shifted their capital allocation towards the top 35 funds in the US private equity market. These funds achieved excellent results and outperformed their peers, attracting 75% of all investments made by limited partners. This shift in capital allocation has made it increasingly challenging for new managers to raise funds because they lack a proven history of success.

However, investors are still dedicated to including private equity as a foundational asset class in their investment portfolios. Private equity produced a 54% return on investment in 2021, which was superior by 12% compared to returns generated in the public stock markets. The latest annual performance report for private equity from investment adviser and manager Cliffwater has been released, and preliminary data indicates that there may be a decline in this asset class by 2023. Nonetheless, unless private equity firms cease operating, this trend is likely to continue.

Emerging managers are still essential for limited partners as they provide diversification and specialize in various industries, which lead to higher returns. Investors recognize the importance of investing in new groups and accept the risks associated with it. Limited partners need to balance the desire for returns with the reality of a challenging fundraising and investment environment.

Despite the difficulties that emerging managers face, limited partners are still dedicated to linking these emerging managers with appropriate funders. In 2023, Calpers announced plans to commit $1 billion to diverse emerging private equity managers as a part of a comprehensive program aimed at aiding early-stage investors.

Investing in smaller managers may pose some difficulties in the near future, but investors are still devoted to private equity and seek out opportunities to invest with up-and-coming managers. Overall, private equity remains essential to the investment strategy of these investors aiming to build a portfolio that performs well over an extended period. Emerging managers still have a chance to thrive, and they remain an important strategy for creating a successful portfolio over a long period of time.

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Corey Singleton, Lead Director North America Email: corey@vcengine.com

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