The Importance of Fund Manager Selection When Assessing Private Markets
Choosing an investment manager is critical in private markets, as their expertise, strategy and track record significantly influence investment performance and risk management.
Investors have a wide selection of potential private investments to choose from, including private equity (PE), real estate and credit. While choosing the right asset class is important for your portfolio, finding the best asset manager for your situation is critical to ensuring that risk and return are successfully balanced.
"There are well-known private market styles that have been around for decades as well as niche strategies and new investment opportunities," says Christopher Ginter, director of private markets at Fifth Third Private Bank. "Private banks can play a key role in helping investors navigate this complex landscape."
For investors, a vital component is understanding how your private bank team selects and vets fund managers and investment opportunities that align with your objectives. While past performance is a key factor, manager selection requires a much more detailed due diligence process that also looks at risks and the industry-specific experience of the managers.
Selecting private funds
When it comes to PE investments, selecting assets often means seeking out specialized PE funds. For instance, in recent months, Fifth Third’s Private Bank team has focused on funds with particular expertise in health care innovation, financial services, and industrials and logistics.
"Industry specialization is usually more conducive to smaller funds," Ginter says. "The larger a fund becomes, the more the managers need to be generalists in order to find enough opportunities to put the capital to work."
Ginter says a thorough selection process begins by connecting with managers through internal networks, industry events and client recommendations. However, identifying fund managers is just the beginning, with the ensuing due diligence process being just as important and perhaps more so.
Fund manager considerations
A thorough assessment of private equity managers ensures investors can access high-quality, experienced and reputable private market opportunities. "What we want to determine through our due diligence process is that there’s an alignment of interest between the manager and the end investor," Ginter says.
The assessment should also include the following considerations:
- Does the firm have the capacity to do what it says it will do?
- Does it have the experience, evidence and team to support its actions?
- Does the firm have operational, administrative and governance controls in place so that investors are protected if something goes wrong?
The selection process looks at the source of a fund’s returns, both gross and net, and whether the fund managers are using an appropriate amount of leverage for their strategy. The timing of deals and how it affects the fund’s internal rate of return is also key to making an assessment. Finally, how a fund’s fees compare with the rest of the industry standards needs to be taken into account.
Your advisor also looks for red flags that suggest a fund could face challenges. For instance, they review legal and regulatory concerns, look for high turnover in third-party vendors such as accountants and auditors, and assess hiring and key employee retention practices.
"We do target smaller-size funds and emerging managers, but we still want to see the complexity of operation and administrative controls that you would expect at a larger organization," he says.
Why manager selection matters
Private market investments have significantly higher return dispersion compared to public markets. In other words, the gap between top- and bottom-performing funds is much broader than in traditional asset classes.
"Over a full market cycle, the top and bottom public U.S. large-cap equity funds may have 200 basis points of performance differential," Ginter explains. "U.S. private equity funds over a market cycle exhibit a range closer to 1,000 to 1,500 basis points between the top and bottom quartile."
This makes the effort that goes into manager selection and due diligence even more critical. In public markets, passive investing can yield reasonable results. Private markets require an active approach to choosing top-tier managers to help generate returns.
"Being private or public doesn’t change the fact that you’re owning or lending something," Ginter emphasizes. "The goal is to find the right managers who know how to execute in their field."
The bottom line
Private markets allow "qualified purchasers" with at least $5 million in assets (excluding their primary residence) to diversify their portfolios further and access unique investment opportunities that align with their financial goals. While the potential return is high, the risk can be as well, especially for investors new to alternative asset classes.
By leveraging the expertise and options of a private bank, investors can explore private market possibilities with the reassurance that the fund managers selected have deep knowledge and a background of performance.
"We’ve always focused on operational and technical experts," Ginter says. "That’s our philosophy for how to create value in private markets."
For more information on private markets, contact your Fifth Third Private Bank advisor.