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Demand for new fund managers creates wave of oversubscribed funds

California State Teachers Retirement System plans to commit to more small and middle-market funds marketed by managers with strong track records, Director of Private Equity Margot Wirth told Buyouts in July. The focus on “breakout groups” is CalSTRS’s response to its $21.4 billion portfolio’s heavy exposure to underperforming mega-funds, many of which were raised in the years leading up to the financial crisis.

“Those vintages are not going to end up terrible,” Wirth said. “We just had a very high exposure to those types of funds.”

California Public Employees’ Retirement System increased its allocation to small and emerging managers, committing up to $200 million to a fund-of-funds vehicle managed by GCM Grosvenor in October.

“CalPERS is firmly committed to emerging manager strategies,” Chief Investment Officer Ted Eliopoulos said in a statement.

State of Wisconsin Investment Board appears to be pursuing a similar strategy.

“Our house view is more bullish on small/mid buyouts and venture capital/growth equity in the U.S.,” according to an investment update presented at its Aug. 13 meeting. The renewed emphasis on small and middle-market funds will require Wisconsin to reduce its exposure to mega-funds, the report said.

Demand for first-time funds has led some investors to dedicate specific allocations to emerging managers, or to make a point of highlighting those strategies in their investment policies. For a list of some of the more significant limited partners in the emerging manager space, take a look at the accompanying table.

Allocating to small and emerging managers carries several benefits for investors. The lower and middle markets, where many emerging managers operate, offer a larger selection of potential assets at relatively low prices. A recent RCP Advisors white paper found that the average EBITDA purchase price multiples in the lower middle market from 2002-2014 was 6.8x.

Meanwhile, research shows that investors don’t necessarily have to sacrifice performance when backing newer groups. Sponsors around the world on their debut buyout, growth equity or turnaround fund generate a median IRR of 10.1 percent and top-quartile IRR of 18.1 percent, according to Buyouts research conducted in late 2013; that compares to a 9.7 percent median and 17.9 percent top-quartile mark for all funds. Investors can also often access these funds at a discount, since newer firms tend to have weaker negotiation positions on fund terms and conditions. 

With demand on the rise, U.S. small and middle market emerging managers—defined here as firms with less than $1 billion AUM and no more than three funds—have raised more than $18.6 billion year to date, according to Buyouts research. Although several market sources emphasize the difficulties managers face in raising their first or second fund, overall strong demand has allowed several to hold oversubscribed closes in recent months. Many others seem poised to hold final closes soon thanks to the backing of major institutional investors.

Many of these management teams assembled a pre-fund track records at other firms: Consonance Capital Partners’s founders worked together at JPMorgan Partners, and LFM Capital features two TVV Capital principals. Others, such as Gauge Capital and Shore Capital Partners, are led by groups where the founding partners worked at different firms. 

  • Consonance Capital Partners, which counts several former members of JPMorgan Partners’s healthcare team among its founders, closed its oversubscribed private equity fund on $500 million in July. The healthcare-focused fund is associated with Consonance Capital Management, a public equity specialist firm with $600 million of assets.
  • Dallas-based private equity firm Gauge Capital closed its debut fund on a self-imposed $250 million hard cap in October, well over its $175 million target. CIC Partners co-founder Drew Johnson launched Gauge Capital with former Symphony Technology Group advisor Tom McKelvey in 2013.
  • Manufacturing and industrial services specialist LFM Capital recently closed its second fund on a $110 million hard cap after just five months of marketing, eliciting strong demand from university endowments, Co-Founder and Executive Managing Director Steve Cook told Buyouts in October. The firm plans to acquire businesses with $15 million to $75 enterprise valuations.
  • The Raine Group is said to be “in the final innings” of its second fundraise, having raised at least $592.3 million as of September, according to one LP advisor. Joe Ravitch and Jeff Sine partnered with talent agency WME Entertainment to found Raine Group in 2009. The firm has stakes in several high profile companies, including Vice, an alternative media group, and Important Studios, a production company led by the creators of the popular cartoon South Park.
  • Gerald Cardinale previously managed $6 billion of assets as the co-head of Goldman Sachs Americas’ private equity funds. A debut fund being raised through his new venture, RedBird Capital Partners, blew through its initial $400 million target. A recent U.S. Securities and Exchange Commission filing indicates that the firm has raised more than $602 million to date, a total that includes $500 million from a single investor. The firm has yet to hold a final close.
  • The Teachers’ Retirement System of Louisiana committed up to $40 million to Turnbridge Capital Partners’s debut fund in August. The Houston and Dallas-based firm grossed a 53.9 percent internal rate of return and 2.3x investment multiple as of March 31 on its pre-fund investments, according to one Hamilton Lane report. Turnbridge Capital closed on its $400 million hard cap in September.
  • Shore Capital Partners, a Chicago-based lower-middle-market healthcare services specialist, closed its oversubscribed first fund on $112.5 million in June. One LP told Buyouts that the firm developed a track record of exiting its pre-fund portfolio companies quickly, typically in two to three years.