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Fundraising in a challenging world: why you should differentiate and innovate

The general capital raising market is becoming increasingly difficult, but opportunities still exist for funds that differentiate themselves.

A challenging market

Speaking at SuperReturn Asia, our panel said multiple factors, including general political uncertainty, the US-China trade tensions and a potential global economic slowdown, were creating a challenging fundraising environment. They added that there had also been quite a few disappointing IPO exits in the past year, and investors were starting to realise they had overestimated unicorns, as the paper money they had been promised failed to materialise. But while they had seen a general slowdown, there was still interest in investing in Asia, where valuations were better than the US.

Emerging managers

In this challenging market, LPs were tending to favour established GPs. But one panellist pointed out that the best talent always wanted to set up their own house, and managers who were trying to establish themselves typically worked harder. The panellist advised emerging managers who were seeking to standout to be able to articulate their competitive strengths and differentiation in one or two sentences. They should also look to establish a track record, even if that meant doing a single deal fund, as this was also a good way of establishing relationships with LPs.

Another panellist pointed out that LPs would also look at emerging mangers’ pre-fund track record to give them a better understanding of their returns and distribution record. Another key issue they were likely to look at was the quality and stability of the team, as new firms had less resources to attract talent, so required a strong leadership. One panellist said they typically used the ‘three-to-five’ rule when looking at emerging managers, namely partners who had worked together for three to five years, had deployed US$300 million to US$500 million dollars of capital together and had a 3% to 5% GP commitment. The panellists agreed that investing with emerging managers could pay off, with one saying data showed that first-time funds outperformed their established peers by an average of 300 basis points. There was only one vintage year in which they had underperformed from 2012 to date.

Considering co-investments

The panel also discussed their goals behind co-investments. One panellist said they typically went into co-investments as a way to mitigate J-curve and enhance portfolio returns, as well as to get to know GPs better through working on a deal together. They generally had a lower risk appetite than the GPs, so it was also a way of adding another layer of diversification. When considering a co-investment, one panellist said they looked to see what the manager was the best at relative to the competition. If the deal was in their ‘sweet spot’, they would consider it, but they would not go into a co-investment if the manager was not putting new capital into the round themselves.

Harnessing technology

Meanwhile, the audience also heard that technology was playing a growing role in investing, particularly as asset classes became more complex. One panellist said it was necessary to use technology to ensure there were no errors in the data investors were given. When they did due diligence and helped clients implement software, they looked at the Excels they were currently working from, and they had never found one without an error. The error could vary between a mismatch of US$2,000 dollars to US$20 million in one case. But they warned that the LPs often did not have enough information to spot these errors.

Another panellist said a lot of LPs were coming to them and asking them to do verification on their behalf on the funds in which they were invested. They added that if they were doing verification on 200 funds, they could not do it on Excel, but had to use software. New technology is also being used to create platforms to connect GPs with LPs. One panellist said small investors were realising that they had to pursue private market opportunities to get alpha. Technology could help to make information more comparable and transparent for them, as many investors wanted to assess opportunities in a more structure manner. But the panel agreed that while technology could help to build trust, it was unlikely to ever fully replace the human element and the importance of relationships.

Unsurprisingly, technology also has a role to play in improving cyber security. One panellist said he had spoken to 20 fund managers during the past three months, and three of them had been hit by cyber fraud issues. They said the importance of ensuring information was secure far outweighed the inconvenience caused by additional encryption.