Alternative investment managers have a Goldilocks problem. They don't want to be so small they can't afford the governance now required, but neither do they want to be too large to invest in smaller, sometimes more lucrative deals.
When Los Angeles-based Crescent Capital Group LP broke off from TCW Group, Crescent executives were concerned the firm wasn't big enough. “When we spun out in 2011, we had $8 billion or so invested and we felt we needed to get bigger to be of meaningful size to Wall Street,” said Mark Attanasio, Crescent co-founder and managing partner. “Conventional wisdom is that international institutional investors are more comfortable investing with large firms.”
Federal regulations also are having a huge impact on the size of alternative investment managers' businesses, said David Fann, president and CEO of San Diego-based private equity consulting firm TorreyCove Capital Partners LLC. “Scale matters, especially as the alternative industry faces regulatory oversight,” he said.
Said Mr. Attanasio: “There are a number of firms that invest in complementary asset classes with less than $10 billion contacting us to try to bolt onto our platform, which is (a new development).”
Investors these days are diving deep into managers' back-office operations, industry insiders say. Two smart investment managers and a good computer is no longer enough. New alternative management firms need at least $10 billion to start, because it takes scale to maintain the operational infrastructure, they say.
But like Goldilocks, investors don't want money management firms to be too large, either.
“It turns out that the smaller deals/funds is where they had the most success,” said Mr. Fann.
Managers of asset classes like real estate, private debt and fixed-income strategies perform best when they have a huge stockpile of capital to invest, said Michael Schlachter, a managing director and head of multiasset-class solutions based in the Newark, N.J., headquarters of Prudential Investment Management.
“In real estate, the bite size for an office building or other large property and a global presence almost screams for a large manager,” Mr. Schlachter said.
In private debt, “there is a lot of merit to being one of the 800-billion-pound gorillas … you need the economies of scale, the trading relationships and research,” he said.
One alternatives area that does not fit easily with a larger, traditional money manager is hedge funds, Mr. Schlachter said, because of compensation structures and unconstrained investment approaches, he said.
This makes it difficult for hedge fund teams to “co-exist with traditional managers,” he said.
Theodore L. Koenig, president and chief executive officer of Chicago-based private equity firm Monroe Capital LLC, said that bulking up in size can be a detriment for certain alternatives strategies. Monroe Capital's midcap private credit strategy would suffer if the firm collected too much capital, he said, adding that “bigger managers “have to buy the market.”