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The Advantage of Emerging Managers: Outperformance Potential

Tiger Global Fund Management
Written by Andy

Tiger Management, the iconic hedge fund managed by Julian Robertson, returned an astounding 31.7% per annum (after fees) since its inception in 1980 to its peak in 1998. Yet despite this formidable record, it is likely that Robertson’s Tiger funds actually ended up losing money for investors overall…

This is because Tiger attracted most of its inflows after the peak of Robertson’s success, and although the gains in the early years were incredible, they were achieved on much lower AUM ????

Tiger Management is a good example of why investing with the right fund manager at the wrong time can prove costly.

Same way Cathie Wood’s investors (in ARKK) are mostly under water given the timing of inflows.

But how do you tilt the odds in your favour?

Emerging managers tend to outperform their more established peers, particularly in their first two years of existence.

This is a well-documented phenomenon. A study from Hedge Fund Research Inc that tracked 564 managers demonstrated that hedge funds in their early years tended to outperform funds in their later years, with higher risk adjusted returns in the first and second years.

What’s more, when examining new funds launched by new fund managers compared to new funds launched by established fund managers, both showed early stage out-performance. However, new manager funds typically outperformed the established manager funds over similar time periods.

Similar results have been documented from the mutual fund sector in a 2014 study published by the National Bureau of Economic Research. The study found that funds that were less than three years old beat their respective benchmarks by significantly more than funds that were 10 or more years old beat theirs—by an average of about one percentage point a year.

Why Newer Fund Managers Often Outperform Established Peers

Why Do Newer Fund Managers Outperform? Let’s summarize the reasons why newer fund managers tend to outperform their more established peers:

  1. Greater Incentive: Emerging fund managers have a strong motivation to outperform because they need to attract assets under management (AUM) and build a successful track record. This drive can lead them to work harder and make more concerted efforts to generate positive returns.
  2. Agility and Focus: Smaller fund sizes allow emerging managers to be more nimble and agile in their investment approach. They can concentrate on their best investment ideas without being constrained by the liquidity or scalability concerns that larger funds face. This flexibility can enable them to capitalize on market opportunities more effectively.
  3. Alignment of Interests: Many emerging managers have a personal stake in their funds’ success. They may have significant equity ownership in their management company or personal investments in the fund itself. This alignment of interests ensures that their financial well-being is directly tied to the fund’s performance, aligning their incentives with those of the investors.
  4. Subject-Specific Expertise: Emerging managers often bring subject-specific expertise to niche markets. They may have in-depth knowledge and experience in a particular sector or investment strategy, allowing them to identify unique opportunities and generate alpha.

These factors give emerging managers some major advantages over their larger counterparts and go some way towards explaining the data shown above. There are many other factors at play and choosing a new fund manager is no guarantee of outperformance – but still, this is a factor that investors should take into consideration.

Choosing an emerging manager can help to tilt the odds in your favour when it comes to picking the right fund.   Additionally, investors should assess the emerging manager’s long-term sustainability and growth potential. As these managers become more established and attract greater AUM, they may face challenges in maintaining their outperformance due to increased scale, asset bloat, and potential style drift.

Ultimately, diversification across different types of managers, including both emerging and established, can be a prudent approach to managing investment risk and capturing a range of opportunities in the market.

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