Emerging Managers: The Texas Way

Why bother investing with emerging managers? Consider the work involved—the sourcing, the vetting, the mentoring, the organizational risk. And with little conclusive data showing that new managers outperform experienced ones, it’s no wonder that, by some accounts, 65 percent of LPs would never consider a first-time fund. But even if just a third of LPs seek out emerging managers, that’s a big number. Particularly when one is among the most influential investors in private equity and real estate: the Teachers Retirement System of Texas. As a $111 billion public pension and one of the largest private equity and real estate LPs in the U.S., TRS “moves the needle” when it allocates capital, so it mostly deals with large funds. Its emerging-manager program gives it access to smaller opportunities that would otherwise pass it by. It also gives the pension fund the opportunity to influence the next generation of managers. Stuart Bernstein, the head of TRS’s $2 billion emerging-manager program, says, “It’s the most exciting space there is. [It] is an opportunity to deliver alpha within a portfolio, negotiate LP-friendly terms, and build long-term relationships with a growing organization.” In 2010, TRS made the deliberate decision to be “one of the best in the country” in investing with emerging managers , and backed that goal with cash. It more than doubled its allocation and expanded beyond traditional private equity to real estate. “It’s our responsibility not only to look out for the best interests of TRS, but to act as a good steward to the emerging-manager space,” Bernstein says. That includes negotiating LP-friendly terms that will benefit all investors, as well as mentoring managers in being a good fiduciary. “It’s about making them institutional quality and ensuring comfort in the marketplace.” Of course, not every LP has the resources of a TRS. The fund invests, either directly or through funds of funds, in 108 private equity and real estate emerging managers. Bernstein manages the program with two other full-time investment professionals, Krista Kerr and Andrew Cronin. But it doesn’t take dedicated programs or a set slice of the portfolio pie for new managers to succeed. Other investors told PrivcapRE that while they don’t specifically target emerging managers, they are open to assessing such opportunities when they arise. Today, competition is the enemy of the emerging manager. Between 2010 and 2012, there was a 50 percent drop in the number of first-time funds closed. Oak Street Real Estate Capital figures show capital raised as a proportion of total real estate fundraising falling from 18 percent in 2010, when emerging managers closed on $8.1 billion of capital, to 11 percent in 2012, when that figure fell to $6.6 billion. The last time the industry saw levels drop to 11 percent was in 2008, when 72 emerging managers raised $15 billion of equity. So with more than 480 managers currently clamoring for LP money, the challenge for aspiring managers is to be heard above the capital-raising roar.