Why Manager Selection Matters More in Private Markets

What happens in private can make a big difference.

Private markets are a growing asset class for high-net-worth clients, potentially offering less volatility and higher returns than public markets. As businesses stay private longer, more capital formation is happening there: Some 80% of companies with revenue over $100 million are now private, per BlackRock. But private fund managers, especially in private equity, show far more variable performance than public managers, making manager due diligence critical.

“The dispersion across managers between good and bad is large,” said Phil Bauer, portfolio specialist at Calamos Investments. “You want to make sure that if you’re going to invest in these markets, that you are investing in managers that have done this, that have the expertise, that are not tourists, that have a long track record of doing it. That’s where a lot of the excess returns come from.” 

Mind the Gap

Return dispersion is almost seven times wider for private equity than for large-cap public equities: There’s a gap of more than 19 percentage points between top and bottom quartile managers, versus about 3 percentage points for public equities, according to research from Moonfare, a private markets platform. Spotting misaligned interests between manager and advisor is a crucial part of due diligence, said Ben Sayer, alternative investments group head at MAI Capital Management. “We’re always looking for ways where it’s that classic Wall Street ‘Heads I win, tails you lose,’” he said. “If you’re walking away with a big performance fee and our clients are not having a good outcome, that means I did something wrong, and we structured this fund very, very poorly.” 

Monish Verma, managing partner at Vardhan Wealth Management, suggested several other things his team keeps in mind: 

• Team structure: In some cases, “we found the principal retired, and so they’ve replaced the head person with someone else,” Verma said. This then requires further questions about the integrity of the manager’s data. 
• Style drift: “We’re looking for things that are not normally done within the mandate that’s been set forth of why we would use that investment,” he said. 

Your Favorite Alt’s Favorite Alt. Given the proliferation of alternative investing, one area of interest for Sayer’s team is general partnership staking, which is essentially buying a minority interest in an alternative investment manager. “Not only can you buy a private-equity manager, you can buy a piece of a real-estate manager and a venture manager and a private-credit manager and infrastructure manager,” Sayer said. “You’re diversified across the landscape of alternatives, and then you’re also hopefully participating in what we believe is continued growth in alternatives over time.”