Pandemics, Downturns, and Emerging Managers

It’s been really hard to write. Everything routine has been disrupted by COVID19 and things have become more uncertain, ranging from the macro in terms of global economic and social systems to the micro like what is my 5-year-old going to ask me to draw today (first it was “water babies”, then fairies briefly, now a range of endangered and exotic animal friends from Yoo Hoo to the Rescue. My drawing skills are improving greatly.) I found comfort in knowing that I wasn’t the only person having trouble focusing and thinking.

Part of me knows that the road to cognitive recovery is to take small steps forward. Nurturing a habit of writing (or of exercise, good sleep hygiene, gratitude or whatever it is for you) helps make a daunting task or significant change more doable. It’s not even so much about breaking down a big goal into smaller goals but rather putting in the effort and building momentum through the accomplishment of smaller, aligned and appropriate tasks. In this case, it’s writing and getting in the word count. This might not contribute to the books I want to write or the cases I need to make to influence decisions related to my work, but getting words out of my brain and onto the screen is exercising my thinking and writing muscles. I hope one day my thinking and writing brain will be strong again. 

When things are stressful or I’ve experienced something disruptive, I find that sticking to routines and daily habits helps me get through it. Others have given me this advice in the past: make those calls, write those emails, thank people in your network, and help others if you can.

I’ve been in a transition from emerging fund manager to investment manager. I have the potential to launch a new fund investing in private equity and venture capital funds. I hope to write more about that in the future. But in the meantime, my attention has been on the pressing challenges experienced by emerging fund managers due to COVID19 and the resultant economic downturn.

Emerging fund managers might not seem like an urgent area of need, but my theory of change has always been about who makes decisions about capital. COVID19 has most negatively impacted under-resourced and under-capitalized people and communities. The intersection of new fund managers, women, and people of colour is where change is needed and my fear is that it is these fund managers – emerging ones – that will also be most negatively impacted by COVID19, thereby deepening the cycle of under-resourcing and widening inequality gaps.

There are two very striking issues I’ve seen: 1) emerging managers on the cusp of first or final closes that have experienced their fundraising momentum and timeline interrupted and 2) emerging managers with valid concerns of being completely denied investment. 

In the Middle of Closing

People are overloaded and overwhelmed with decisions right now. If you’re trying to close your fund, keep structures, terms, and information simple. Make it easier for investors to say yes. This has always been true, but couldn’t be more true now.

In times of uncertainty, I think people will double down on what’s familiar to them. COVID19 introduces risk that is global and incredibly uncertain. This is more than investors losing confidence in one particular industry or asset class. This is more than part of our economic system – like financial services and credit – being disrupted. This is a health crisis AND multiple industries are impacted. Entire ways of working, living, learning, and connecting are interrupted. The divide isn’t between equities and fixed income nor between technology and real estate. The divide is between capital and labour. There is so much uncertainty that people are retreating to low-risk situations and that may mean focusing on the familiar. 

Investors with capital appear to be taking one of three approaches: 1) wait and see, 2) doubling down on the people they believe in and 3) open for business, but cautious. If you need to get a fund launched, you need to segment your potential investors even more diligently, so that you may concentrate your efforts on those investors that believe in you and your thesis.

On the point above about investors doubling down, investors are focusing on existing portfolio funds – the people they know and believe in. Some may double down on areas such as gender-lens investing perhaps because this is where they have been investing (and therefore is familiar). Some may be very future-oriented and looking for new (and possibly bargain) opportunities – this may very well be their default mode of operating during volatility and crisis. Anyone that was on the fence about an entirely new endeavour, risks little by saying “No” at this time.

Samir Kaji of First Republic Bank remarks about family office and high net worth individuals investing in venture capital funds, “Emotional anxiety remains high, particularly with those that started investing in VC post 2009.  I’m seeing soft commitments from this group dissipate VERY quickly with GPs I’ve talked to.”

For fund managers that are approaching a first or final fund close, if viable, close on whatever you can even if it is less than your target. Stay in the game, stay alive.

Asset Allocations

Large institutional investors have asset allocation targets meaning their private equity and venture capital strategy, if they have one, should fall within a percentage range of their total portfolio. The impact of COVID19 on public markets means allocations to public equities and fixed income are likely lower than their targets and allocations to private equity and venture capital is higher than targeted. This will also have an impact on funds currently raising and it’s worthwhile reconfirming the availability of capital to invest in this sector (and your fund).

Samir Kaji notes, “Institutional investors have asset allocation targets to deal with, and are generally unlikely to make any 2020 investments outside of A) Existing managers B) Those they have been tracking for some time C) NO Brainer funds (i.e. top GP from a good firm, or top .1% operator, etc.)”

Emerging Managers – Leading Edge or Death Knell?

Angelo Calvello wrote in March 2020 in Institutional Investor, “As could be expected, large, established managers will weather the storm. Many independently owned active managers, however, will be forced out of business — some because of poor performance, but others who generate good returns will also shut their doors because of cash-flow problems.”

In January and February 2020, the British Private Equity and Venture Capital Association surveyed more than 40 global institutional investors and family offices to get their perspectives on emerging markets. 96% of those surveyed felt that there were advantages to investing in emerging managers over established firms. Respondents cited innovation, ambition (hunger to outperform), focus on unique investment strategies, greater ease to align economic incentives and negotiate terms, and greater likelihood of forming meaningful strategic partnerships as being the key benefits. 

Likewise, Cambridge Associates published a report on venture capital in January 2020 noting that top returns are not confined to a few dozen firms. New fund managers (managing their first or second fund) and developing fund managers (on third or fourth fund) consistently rank as some of the best performers.

Both studies were conducted before the World Health Organization declared a global pandemic, so whether or not these views continue to hold true have yet to be seen.

Near-term Focus on Grantmaking

Foundations are facing a lot of demand and pressure from the grantseeking side of their organizations. When there are communities around them struggling to stay healthy or to keep the roofs over their heads or are facing increased violence or precarity, attention must go towards current spending.

It makes sense to me to focus heavily on spending during a time of crisis and once new routines and some new sense of stability, foundations and other capital holders can think about planting the new seeds for the future. We have to plant new seeds, as investments, to rebuild surpluses and resources, and the thoughtful application of capital is needed to weather these kinds of storms in the future.

The current health and economic crisis feels very different to me than the dot-com and the 2007-08 financial crisis. Our health is at risk. Our main streets are ghost towns. Our ability to connect in-person with each other is disrupted. The inequality gap is exacerbated. Yes, there are opportunities, but close to a million Canadians filed for employment insurance in the first week of the COVID19 lockdown (more than 30 times the number in the same week the previous year). Our way of life is severely negatively impacted and that requires a pause and thoughtful reflection about what’s next.

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