CLOSING THE PENSION FUNDING GAP: Emerging Managers Have A Role

The funding gap for public pensions is enormous. This should not be breaking news to anyone. Underfunded public pension plans have been a major discussion topic over the past few years, receiving a lot of media attention and notably being detailed in a couple reports from the Pew Center on the States: a 2010 report, The Trillion Dollar Gap focused on state retirement systems and a 2013 report, A Widening Gap in Cities focused on municipal retirement systems. As you might expect, similar gaps exist for most other pension plans as well, including corporates, Taft-Hartleys and retiree health care funds.

The approaches to address these shortfalls are limited: 

• increase direct funding, 
• reduce benefits and 
• add "alpha." 

So how can smaller investment managers (Emerging Managers) play a role in the solution?

Empirical data shows that Emerging Managers, systematically by asset type, generate superior returns to their larger cousins. Therefore the demand for Emerging Managers should grow as the search for excess alpha accelerates.

Here are a few of the many examples of this outperformance: 

• Smaller Hedge Fund Managers Outperform: A Study of Nearly 3,000 Equity Long/Short Hedge Funds, 
• No Contest: Emerging Managers Lap Investment Elephants and 
• Survival of the Nimble: Why Smaller Investment Mangers Outperformed Larger Managers Despite a Challenging Market Cycle for Fundamentally Based Active Mangers. 

As we have previously discussed, Emerging Managers need to address their capacity issues in order to penetrate and thrive in the institutional investment management space and large asset allocators need to adapt their practices to allocate more efficiently to Emerging Managers.

Clearly, the pension funding gaps will not be resolved by the use of Emerging Managers alone. It is going to take public policy reform to resolve these daunting challenges if we have any hope of solving the funding calculus. Nevertheless, Emerging Managers have a role and it behooves everyone to make some adjustments and use them as part of the solution. Much more to come from our team on this topic.

Lessons Learned: Small managers can be part of the funding gap solutions.

Lawrence C. Manson, Jr.
Chief Executive Officer
NexTier Companies, LLC

EMERGING MANAGERS: The Alpha Story

Despite the ever increasing amount of evidence that smaller managers (Emerging Managers) across all asset classes generate excess alpha, small managers still experience significant barriers to market entry and growth.

The Opportunity

Large allocators of assets in the institutional investment world are increasingly seeking the higher rates of return that Emerging Managers can provide, as Emerging Managers are seeking additional assets to manage.

The Problem

Such allocators of assets and their advisors, consultants and gatekeepers, do not have efficient mechanisms or maybe even the talent and experience to weigh the business risk associated with selecting any given Emerging Manager. Emerging Managers generally do not have the organizational depth to address the traditional needs of large allocators, the so-called “elephants.”

The Observation

By and large, Emerging Managers focus their energies on their products and the respective performance, and in so doing provide excellent returns but ignore vital infrastructure issues. Nevertheless, the large allocators continue to benchmark them against their much larger cousins with respect to business risk. This generally leads these allocators and their advisors, consultants and gatekeepers to default to “larger is better,” due to less perceived business risk without further examination.

Even though Emerging Managers are simply small businesses founded by investment managers, they often do not have the bandwidth to manage their business platform without sacrificing performance. Most Emerging Manager programs were originally designed to level the playing field. However, the new age programs should be focusing on more than market entry opportunities, but rather business development and successful business transitions and exits. Why? The Emerging Manager life cycle being understood and supported will go a long way in deriving “sustainable” excess alpha that Emerging Managers are providing. Much more to come from our team on this topic.

Lessons Learned: Emerging managers shouldn't be ignored.

James A. Casselberry, Jr.
Senior Managing Director
NexTier Companies, LLC