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If Yale were Socrates in the endowment approach world, MIT would be Plato.
In Philosophy 101, we learned: Socrates believed in being just, he states that everything has a role to play, and must play it well enough. He also believed that everything is characterized by a virtue that has a direct relationship with the performance of its function. While Plato, argues that injustice cannot be better than justice, he argues that each function is dependent on the community one finds himself. That is, a person's function and his ability to carry it out effectively is highly dependent on the community in which one lives.
What is the function of emerging managers in the allocator’s portfolio? We think it depends on what kind of allocators you are. If you can identify young and talented managers at a very early stage of their professional career and you can take a long-term bet on their future growth, the emerging managers have a valid function in your portfolio. If you cannot make such a judgment and bet, the emerging managers are not a very good fit.
MIT recently launched a website titled “Emerging Managers” https://mitimco.org/emerging-managers/. You don’t need to read the rest of this email if you can click the link and go to MIT’s website. It’s worth reading.
I found no surprise in MIT’s thoughts, but am grateful that they published this to a wide audience so that the allocators’ community has an opportunity to think. Due to the high execution challenges, emerging managers are not for most allocators, but we should at least think about how we should face these challenges. I also compared MIT to Yale using the example of Socrates and MIT, but it doesn’t mean Yale doesn’t find “function” in emerging managers. It’s actually quite opposite as I know Yale actively invests in emerging managers. MIT refined the idea of emerging managers, which is not very different from Yale’s fundamental belief.
From the MIT website:
Very often we become skeptical if the fund size is too small. Why don’t they have more money from previous experiences? How can you say you can make money if you haven’t made enough money for yourself? Can they survive before they hit the breakeven point? However, we should also help young managers to build their equity by providing capital when anyone else wants. Everybody starts from somewhere like Steve Jobs started Apple at his garage.
We want to generate a higher return. Why don’t we take ownership to compensate? However, this decision will put me in a conflicted situation as we cannot help the manager to raise more capital to maximize the return, resulting in a lower return on capital. This special connection also makes it difficult to terminate a relationship when we have to.
Can we commit 10 years with a manager with nearly zero history? Isn’t it too much? However, a stable capital means peace of mind. No matter how smart they are, the managers are human beings and their performance is influenced by non-investment-related matters. Eliminating fear of losing business can improve their performance in a long run.
We are the early supporters and want to help the managers, so they should listen to us. However, we also need to trust our managers’ judgments on portfolio and business management. They definitely know a lot of things better than us and that’s why we invest. Why do we want to control them?
Here are MIT’s answers to my questions.
Emerging Manager Examples (from the website)
Here are some examples of firms we backed in the past few years:
A one-person stockpicking firm based in San Francisco with $10 million of AUM (as you can see, we like small firms with long runways!)
A private equity firm based in New York operating with an evergreen fund structure (as you can see, we like unconventional firms!
A real estate firm in San Francisco transitioning from deal by deal capital to a discretionary fund structure (as you can see, we like finding firms early!)
A one-person stockpicker, based in Mumbai, with a decade plus track record of compounding his own money, who now manages MIT’s money alongside his own
A private growth equity firm based in London raising its first institutional fund