September 30, 2017

Emerging Managers: Minefields or Diamond Mines?

A thoughtful venture portfolio needs to include emerging managers @CRMcCrea @WeathergageTeam

Are emerging managers risky? Many investors in venture funds treat them as if they are not only risky but toxically so. And yet, we find that many of the best performing funds of all time have been “Fund I’s.” We believe investors’ avoidance can be attributed at least in part to concerns about career risk and headline risk rather than to capital risk alone. In our view, the question one should really be asking when assessing risk with any manager is “Will your venture capital portfolio provide you with the hurdle rate of return that you need?”

At Weathergage, we have observed that investors in venture capital seem to accept a much lower hurdle rate of return when investing in branded venture capital firms versus emerging managers. One can make the case that some premium for emerging managers is appropriate, but setting the hurdle at infinity is a cop out, and from an opportunity cost perspective a very expensive one in a world where some emerging funds shoot the lights out.

There is an adage that “investing in emerging managers is a minefield.” Our experience suggests comparison to a diamond mine makes for a more accurate metaphor. While it may take some skill to tell the rocks from the diamonds, it’s a skill that is richly rewarded. Overall, we believe a manager of a venture portfolio ignores emerging managers at its peril.

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Weathergage
A nautical term that indicates a favorable position relative to the wind. A ship that "has the weathergage" has the initiative and hence a significant advantage over its rivals.