Hamilton Lane’s Emerging Manager platform, with approximately $17 billion in AUM/AUS,1 provides clients with early access to the firm’s top selection of rising fund managers and transactions. The depth of our global platform coupled with our powerful technology solutions and information advantage enable us to allocate capital to managers we believe are the top-tier, next-generation strategic firms of the future. We caught up with Katie Moore, Head of Emerging Managers & Diverse-led Investments, to understand the current landscape of the emerging manager space.
How does Hamilton Lane define emerging managers?
We define an emerging manager as a GP who is raising a first, second or third institutional fund in the original fund series. We don't cap it by fund size or AUM, but we do evaluate the target fund size to execute on the strategy and how the firm expects to scale over time.
When did Hamilton Lane get into the emerging managers space? How does that fit into our portfolio construction approach?
We've been an active emerging manager investor since the firm’s inception. In the early days, our clients engaged us to assist them in navigating and selecting from an expanding group of firms and strategies, many of whom have since grown to become some of the largest and most successful firms in the industry. As a result, the process of engaging with and selecting these next-generation groups has always been an integral part of our portfolio construction approach. This emphasis is particularly evident in the primary buyout space where approximately 95% of our investments have been made to small, mid-sized and emerging managers.2
Today we maintain our open-door policy for meeting new funds in market each year, which affords us a great vantage point for comparison and assessment. Clients continue to look to us to help them identify and evaluate the next successful firms of the future and to construct high-performing portfolios around those evolving relationships. What has also remained consistent is our view that emerging managers should be an integral part of core portfolios and we continue to hold the managers that we select to those high standards.
Describe the evolution of the emerging managers space over the last few years.
As we all know, numerous highly successful, dedicated emerging manager programs have now reached their second decade of operation. However, most of those programs had been concentrated within a small group of large U.S. public pension funds. During the last economic cycle, as returns for small and mid-market managers remained strong and private market allocation pools grew, other LP pools, such as endowments and family offices, increasingly focused more of their time and attention on supporting these small and emerging managers.
In addition, the ability to leverage virtual platforms, coupled with a growing interest in co-investment, also drove an increasing number of investors to spend time with an expanded list of emerging funds. These newer sources of capital have significantly increased from the last cycle and we're enthusiastic about the momentum.
How should investors think about emerging managers in terms of strategy and fund size?
Emerging managers represent 35-40% of our new deal flow annually, so it’s a big undertaking for our firm to screen and meet the market. A large majority of those emerging firms typically manage smaller funds and receive fewer dollars than their established peers, as success is less proven.
When you break down the strategies, the biggest influx of new dollars that have come into the emerging manager space has really been in the buyout and venture strategies. In small- and mid-market buyout, we generally see groups that raise a few hundred million dollars up to $1 billion in their first or second fund, and their subsequent growth depends on the returns and the validation of their strategies.
In the case of venture capital, the process of launching a new firm typically involves lower initial capital outflow for a team and operational costs. Additionally, the venture capital ecosystem benefits from a significant pool of experienced entrepreneurs with a strong commitment to facilitate the growth of other companies. As a result, the venture capital space has witnessed substantial growth in the number of emerging managers, although the inflow of capital into this space has recently moderated. These emerging venture capital firms range in size with firms managing as little as $5 or $10 million, to larger groups commanding up to $1 billion in assets.
Private Markets Fundraising by Manager Type
# of Fund per Vintage Year
Other exciting areas of growth are in ROW geographies where our team is spending a lot of time. This is also a great environment for new credit managers. Over the last cycle, big firms with large pools of capital were the dominant players in the private credit space and still remain that way. What has changed is the smaller deal market with an expanding list of equity firms who are now looking for a broader set of debt providers that can fill that gap. As expertise has grown within these firms, we expect to see more credit managers start to raise new and strategically targeted pools of capital.
What does the fundraising environment look like for emerging managers?
Fundraising is difficult in general, but it is significantly more challenging for emerging managers. The task of launching a new firm is inherently demanding before adding today’s market dynamics such as valuation uncertainty, LP overallocation and aggressive competition from the established firms raising more products. It’s not easy, but then again, I don’t think it should be, as the bar is still high for success. The challenge of choice has never been tougher for allocators and for GPs looking to stand out; it takes time and a big focus on relationship building. On the positive side, we don’t think a firm’s success is defined by how long it takes between initial and final close. Many of the established GPs are also in market for up to and over two years these days. Also, while the current market environment is challenging, it hasn’t materially paused the creation of new firms. The groups that tend to stand out are the ones who are innovative, build trust over time and run full speed ahead with both fundraising and deals.
How do emerging managers perform relative to their more established peers?
When you look at the data, the dispersion of returns for emerging managers is much wider than its established peers. In buyout, for example, the bottom of the top to the top of the bottom (read that twice) is about 2000 basis points or more. That being said, top-quartile emerging managers do provide exceptional returns, often in line with or better than their established manager peers, but there are other risks that need to be considered. We are highly selective and leverage our three decades of data and insight to drive manager selection in the context of building a properly diversified, top-performing portfolio. We are big believers that having a strong portfolio construction approach is one of the most critical elements when selecting new funds.
Dispersion and Returns of Emerging Managers
By Asset Class, Ordered by Spread of Returns, Vintages 2010-2022
In addition to seeking strong returns, what do you view as the business case for emerging managers?
There are three key elements: specialization, diversification and long-term partnership.
As the industry has become more complex, many of the emerging managers have been able to build their strategy around areas where they have strong expertise. These are groups that often specialize in a deal size or one or two verticals and have unique sourcing networks. They also strive to take the best of what they've excelled at in their prior firms and align themselves with likeminded LPs who want to support them as they redesign the playbook for what can make their firms successful in the future. For us, these funds are often new and complementary areas to the exposure we have within our existing portfolios.
If you look below the macro layer, there is a case for diversification. In terms of buyout and growth equity, the deal sizes and the number of deals per fund are significantly smaller for emerging managers. These groups often build portfolios with five to 10 deals in some cases, so the winners can really drive outperformance. The deal sizes are also two times less, on average, than established managers. As those groups scale over time and move up market, refilling the pool of smaller growth and lower middle-market companies is essential for our portfolios across sub-strategies.
Lastly, private equity is a long-term asset class, so building conviction early and developing partnerships that will scale and evolve over time are a big key to our success as a firm. When I think about what we are looking for in an emerging manager, yes, we’re seeking great returns, but we're looking for those long-term partners. The groups that we can grow with beyond the third fund. Relationship building is paramount, and our job is to develop that team and introduce those relationships to our clients.
How is diversity playing out as a role in overall decision making?
Diversity is an important component of our underwriting. Our platform today has approximately $50B in AUA/AUM committed to diverse-led primary funds.1 With our investments, the goal is to generate strong returns but to do that, we have to analyze all of the risks and not just the risks we do or don’t want to talk about. We’ve seen that DEI risks are real risks and that companies could be less profitable if they ignore them.
When we think about diversity, we are really focused on diversity of thought. During diligence we assess a variety of factors, including the risk of groupthink, the effectiveness of diversity policies, and social practices, and incidents at the portfolio company level (leveraging our technology partnerships with Novata and RepRisk). Additionally, when we evaluate a firm or company, we look at ownership, economics and leadership diversity. Once we gather all the relevant information, we then use that data as a factor in our decision-making process. Gathering that data is important for many reasons, but prudent risk management is just good business.
To sum it up, what are some key themes across our successful emerging manager relationships and how do you think these firms can sustain success over time?
The key themes for success have always revolved around partnership. We select groups that we think can be great investors and great portfolios managers where our clients will be able to build relationships over cycles.
We place a strong emphasis on identifying groups with a strong culture and a competitive edge that can adapt and evolve over time. Alignment and appropriate incentivization are of utmost importance to us. We are less inclined to support emerging managers who relinquish economic benefits without a well-thought-out strategy for the growth of their platform. Instead, we favor managers who find new ways to strategically reinvest in their operations and invest in the development of their talent.
Additionally, exploring co-investment opportunities and other equity or credit avenues provides us with greater insight into the types of deals and value-creation strategies that set a firm apart.
Finally, our cardinal rule is to partner with groups that excel in listening, communicating and providing a high level of transparency. Whether a GP has five or 500 LPs, the common thread in our most successful relationships is a comprehensive understanding of and appreciation for the evolving nature of the partnership, extending from senior leadership to the entire team.
1As of June 30, 2023
2 As of March 30, 2023
The information contained in this presentation may include forward-looking statements regarding returns, performance, opinions, the fund presented or its portfolio companies, or other events contained herein. Forward-looking statements include a number of risks, uncertainties and other factors beyond our control, or the control of the fund or the portfolio companies, which may result in material differences in actual results, performance or other expectations. The opinions, estimates and analyses reflect our current judgment, which may change in the future.
All opinions, estimates and forecasts of future performance or other events contained herein are based on information available to Hamilton Lane as of the date of this presentation and are subject to change. Past performance of the investments described herein is not indicative of future results. In addition, nothing contained herein shall be deemed to be a prediction of future performance. The information included in this presentation has not been reviewed or audited by independent public accountants. Certain information included herein has been obtained from sources that Hamilton Lane believes to be reliable, but the accuracy of such information cannot be guaranteed.
This presentation is not an offer to sell, or a solicitation of any offer to buy, any security or to enter into any agreement with Hamilton Lane or any of its affiliates. Any such offering will be made only at your request. We do not intend that any public offering will be made by us at any time with respect to any potential transaction discussed in this presentation. Any offering or potential transaction will be made pursuant to separate documentation negotiated between us, which will supersede entirely the information contained herein.
Certain of the performance results included herein do not reflect the deduction of any applicable advisory or management fees, since it is not possible to allocate such fees accurately in a vintage year presentation or in a composite measured at different points in time. A client’s rate of return will be reduced by any applicable advisory or management fees, carried interest and any expenses incurred. Hamilton Lane’s fees are described in Part 2 of our Form ADV, a copy of which is available upon request.
The following hypothetical example illustrates the effect of fees on earned returns for both separate accounts and fund-of-funds investment vehicles. The example is solely for illustration purposes and is not intended as a guarantee or prediction of the actual returns that would be earned by similar investment vehicles having comparable features. The example is as follows: The hypothetical separate account or fund-of-funds consisted of $100 million in commitments with a fee structure of 1.0% on committed capital during the first four years of the term of the investment and then declining by 10% per year thereafter for the 12-year life of the account. The commitments were made during the first three years in relatively equal increments and the assumption of returns was based on cash flow assumptions derived from a historical database of actual private equity cash flows. Hamilton Lane modeled the impact of fees on four different return streams over a 12-year time period. In these examples, the effect of the fees reduced returns by approximately 2%. This does not include performance fees, since the performance of the account would determine the effect such fees would have on returns. Expenses also vary based on the particular investment vehicle and, therefore, were not included in this hypothetical example. Both performance fees and expenses would further decrease the return.
Hamilton Lane (Germany) GmbH is a wholly-owned subsidiary of Hamilton Lane Advisors, L.L.C. Hamilton Lane (Germany) GmbH is authorised and regulated by the Federal Financial Supervisory Authority (BaFin). In the European Economic Area this communication is directed solely at persons who would be classified as professional investors within the meaning of Directive 2011/61/EU (AIFMD). Its contents are not directed at, may not be suitable for and should not be relied upon by retail clients.
Hamilton Lane (UK) Limited is a wholly-owned subsidiary of Hamilton Lane Advisors, L.L.C. Hamilton Lane (UK) Limited is authorised and regulated by the Financial Conduct Authority (FCA). In the United Kingdom this communication is directed solely at persons who would be classified as a professional client or eligible counterparty under the FCA Handbook of Rules and Guidance. Its contents are not directed at, may not be suitable for and should not be relied upon by retail clients.
Hamilton Lane Advisors, L.L.C. is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 in respect of the financial services by operation of ASIC Class Order 03/1100: U.S. SEC regulated financial service providers. Hamilton Lane Advisors, L.L.C. is regulated by the SEC under U.S. laws, which differ from Australian laws.
Any tables, graphs or charts relating to past performance included in this presentation are intended only to illustrate the performance of the indices, composites, specific accounts or funds referred to for the historical periods shown. Such tables, graphs and charts are not intended to predict future performance and should not be used as the basis for an investment decision.
The information herein is not intended to provide, and should not be relied upon for, accounting, legal or tax advice, or investment recommendations. You should consult your accounting, legal, tax or other advisors about the matters discussed herein.
The calculations contained in this document are made by Hamilton Lane based on information provided by the general partner (e.g. cash flows and valuations), and have not been prepared, reviewed or approved by the general partners.
As of October 24, 2023