Some of the world's largest pension funds are increasingly turning to emerging managers to generate alpha, particularly in alternative asset classes where more nimble players might have an edge.
“There is renewed interest in emerging managers, stemming in general from investors looking for diversity among managers — not necessarily just on an outperformance level but also (in terms of) diversity in investment ideas, which may be coming from smaller firms,” said Andrew Junkin, managing director at investment consultant Wilshire Associates Inc. based in Denver.
Furthermore, major organizational changes at larger firms have led some investors to opt for smaller managers “with the view that they may be more nimble in certain areas of the market,” Mr. Junkin said. “Smaller managers can provide organizational stability, and more of them tend to fall into the (women and minority business enterprises) category.”
In the U.S., regulatory and social pressure over the years has led many public pension funds to implement emerging manager programs dedicated to attracting more women and minority business enterprises. But even among institutions that don't have the same requirements, commitments to emerging managers are rising, sources said. More recently, these programs have been broadened in terms of asset classes to include more alternatives including hedge funds, private equity and real estate.
“Alternative strategies are well-suited to the emerging manager construct, as the alpha component of returns is more meaningful” compared to traditional asset classes, said Mark Yusko, chief investment officer of Morgan Creek Capital Management, which is running emerging managers strategies for the $21.2 billion Employees Retirement System of Texas and the $108.9 billion Teacher Retirement System of Texas, bothTeacher Retirement System of Texasn Teacher Retirement System of Texas, both of Austin.
The difference between the top and bottom performers in fixed income, for example, is maybe 100 basis points. Among alternatives managers in asset classes such as private equity and real estate, the difference could be “as high as thousands of basis points,” Mr. Yusko said. “The bigger (performance gap) between the best and the worst managers means more opportunities for managers to differentiate themselves through alpha generation.”
In addition to the two Texas giants, other pension funds expanding or considering adding to their emerging managers programs include the e274 billion ($355 billion) Stichting Pensioenfonds ABP, Heerlen, Netherlands; $245.3 billion California Public Employees' Retirement System, Sacramento; the New York City Retirement Systems, with about $122 billion for five city pension funds; and the £36 billion ($58 billion)New York City Retirement Systemscramento; the New York City Retirement Systems, with about $122 billion for five city pension funds; and the £36 billion ($58 billion) BT Pension Scheme, London.
“What we've found is that by engaging with smaller managers, we were able to help them build a (business) structure that's more operationally robust and transparent,” said Mark Barker, co-CIO and founding partner of Hermes BPK Partners, which has $2.4 billion in hedge fund-of-funds assets under management. Hermes Fund Managers Ltd., which is owned by the BT pension fund, holds a majority stake in Hermes BPK.