“Oh….you’re a first time fund?”
We may be a little naïve…
The team at Alderwood has been doing what we do now for more than 20 years. In fact several of us have been in the asset management industry for 30 years or more. For the last two decades together, the team has been sourcing new investments, completing deals, making some excellent investments and yes, making some mistakes along the way. Every asset manager we meet, each opportunity we see, each investment we make and each mistake or near miss we have, teaches us something and makes us better investors as each year passes.
We’ve gained our experience in different guises. We’ve invested in the asset management sector as employees of a large financial institution – albeit in a division which didn’t exist until we set it up – and we’ve invested as minority partners in a start-up firm with our own capital at risk. We grew that business from day one to c.$91 billion of assets under management1.
In total, during those 20 years together we’ve bought businesses with nearly $0.25 trillion of assets under management and those businesses have added more than $1 trillion of assets since they were purchased.
We’ve done deals in 14 countries and overseen businesses with over 2000 employees across the globe, we’ve dealt with just about every major regulator and owned or managed businesses in almost every major asset class.
So, with all this experience, with the badges, medals and the scars of battle, we started Alderwood as the culmination of everything we’d learned; as the purest expression of how we believe that investments in asset management should be made.
Except that to our surprise, when we started to engage with Placement Agents and some industry connections we were told:
“you’re really interesting……for a first time fund”.
We liken this experience to going into a bar as a 40 year-old to buy a drink and being told “sorry we can’t serve you – you look underage.” It’s kind of flattering to be regarded as new or novel but once the initial glow wears off it’s actually annoying and very inconvenient.
As a firm we tend to take the view that we must always listen to the clients. It’s their money or, it’s money that they’ve been entrusted to look after by their clients, so we can either argue with them, or try to work out why they believe what they believe and try to allay their concerns.
Sitting back and rationalising the ‘first-time manager’ concern we can see that it is grounded in reality; first time managers can bring additional risks – we’ve invested at an early stage ourselves – and so we can appreciate that these are real. Let’s look at them one by one.
Of course, it’s rare – and foolhardy (although trust us, it happens) – for a new manager to be setting up to manage something different to the asset class or type of investing they’ve been managing before. If they do this clients will quite rightly walk away; there are almost certainly others doing it with far more experience, so no rational institution is going to give capital to an investment team to learn on the job.
So, in most cases the new firm is going to be managing a continuation of an existing strategy that has been pursued by the team at a previous firm. Why should an investor be cautious about that?
Well, to be fair, in many cases an investment process doesn’t exist in isolation. The ‘new’ team’s historic investment decisions may have been supported by a central research function which is not part of the new firm, their views may have benefitted from institutional level macro calls which informed their asset allocation or their currency returns may have been helped by an active FX process which they no longer have access to. Even within their process the investment decisions they made may have been supported by a quant screening system or investment tools that were the property of the past employer and are no longer available to the team in its new guise. Perhaps the firm they worked for had a profile and connections which guaranteed access to deals or to lower than average transaction fees.
Looking across the individuals within the Alderwood team, we invested from 2000-2010 in a larger firm with huge resources, a massive balance sheet and lots of support. We sourced some of our own opportunities, negotiated our own deals and did most of the work within the team, but nonetheless it would be a valid objection to say that the team on its own wasn’t the whole story; we had a supportive, knowledgeable boss and a lot of ‘plumbing’ and resources at our disposal which we left behind when we left. We were in an institution which had a formidable balance sheet and excellent connections with investment banks and other service providers. So perhaps our first ten years’ experience of investing as a team is not quite enough to claim we aren’t a ‘first time fund’.
However, in 2010 we set up Northill Capital with a single investment team which had no wider institutional investment framework. We were associated with an entrepreneurial sister organisation and had a board with collectively a strong general business knowledge but we were the only investors in our firm. The process was ours and the framework and systems we used were ours. So, in the case of the investment process it would be hard to argue that we don’t know how to do it ‘on our own’ – it’s business as usual for us.
There are other related risks to consider though.
We’ve often seen start-up managers fail when it comes to business risk. Whether it’s hubris, ego or just naivety, most investment teams underestimate much of the activity that goes on around them to make a successful firm.
Reports get written, clients are looked after, systems are planned, installed, maintained and upgraded, facilities are managed, accounts filed and bills paid. These things are simple and go unnoticed when it’s going smoothly, but we have seen first-hand how quickly a business can degenerate when these things aren’t done properly. The investment talent is often the senior management team and they need to be focused on investing; three hours spent trying to figure out an accounting issue or trying to retrieve the domain name from a web provider because no one’s remembered to renew the registration or reviewing draft number seven of a compliance manual can easily turn into a huge distraction for key staff.
Sometimes investment team members get too interested. We’ve seen portfolio managers spending days building a complex spreadsheet to compare mobile phone tariffs to save a few thousand dollars a year. In their previous firm someone handed them a phone, connected, charged, and upgraded when needed, with the simple instruction “don’t lose it”.
It even applies to client interactions.
The investment team regard sales as ‘easy’. In the larger firm, clients appear in the investment team diary as if by magic, roadshows come in the form of a pre-filled itinerary with flights, hotels, contact names and transport all laid on…but someone’s doing all that work in the larger firm. In the new firm it’s all hands on deck – there may be an IR person but they still need managing, and if you want people to take you seriously in new firm the investment team has to be involved in the client interaction at a very early stage. They may well lack the skills, time, or experience to do this so, once again the distraction, the dislocation and the potential for mishaps when moving from a large firm to a start-up is huge.
At Alderwood many of us have already held senior non-investment roles in large and small firms. When we set up Northill we had two rooms and some desks – nothing else.
We learnt how to build a business pretty quickly. That’s also why the first hires at Alderwood were in legal, compliance, finance and IT before we even thought about the investment or client activity. If we didn’t have the required expertise in house, we bought it in; hiring a major compliance consultancy to support our regulatory applications, an experienced industry consultant to manage our administrator and depositary search and a contractor to develop, build and manage our facilities and IT.
Another significant risk for start-up firms is financial risk.
Many start-ups badly underestimate the costs of doing things properly. Too often the money is spent on marketing, cool art and front office tech kit and the hard yards of a $250k legal bill or outsourcing review isn’t factored in. It’s a little like renovating a house. Those who’ve done it before, know that the key word is ‘contingency’. If a firm is inadequately capitalised it will cut corners – in hiring, in infrastructure and in governance. Doing RFP’s and selection processes for key service providers is expensive and time consuming but that’s how things are done properly. Having independent directors and auditing every entity is expensive but it’s how things are done properly. Having robust IT contracts, IT assurance protocols and cybersecurity protection is expensive and time consuming but it’s how things are done properly.
In these, as in so many more areas, you can convince yourself that what you are doing is good enough for now, but in large well-established, best-in-class firms they do things properly. If you want to avoid being regarded as a start-up those are the standards you need to have from the start; it’s very expensive.
Because of our past experience this is the model we followed at Alderwood. We’ve over capitalised the firm so that, from the start, we can do things right. Our day one model is our year 3 model – we’ve built the firm to manage at capacity from day one.
There are two reasons for this approach. Firstly, the obvious one that clients who back the firm at its birth should not be expected to take more risk than they would investing with an established firm. Cyber risk, operational risk, risk management and compliance – to name just a few areas – are the same whether the firm is large or small. Investors cannot be expected to give a ‘first time fund’ a free pass – why should they?
Secondly, there is a reason which to our minds is far more important. In a properly capitalised firm, the management and staff don’t need to worry about the burn rate of capital and whether they’ll be able to survive to the fund’s closing. They won’t spend time in cost-cutting meetings instead of investing clients’ capital or worrying about their future. That alone is the most important factor for us.
This leads us onto our final point. As we’ve said, we are genuinely puzzled to be regarded as a ‘first-time fund’. Everything we’re doing now, we did before. As it’s now third time around for this team, we will be even better for our past experience. However, there is one area where a first time fund does have some advantages.
In all firms with a single fund there is total focus on the task in hand. Everyone in the business knows that the future of the firm is vested in a single portfolio. Every decision to invest or to pass on an investment is magnified. It’s not Fund IV or Fund VII, there is only one portfolio and everyone in the firm’s future depends on it being a success. When we speak to LP’s they sometimes tell us that they are concerned that many of the firms they look at now have so many funds and such large teams that accountability, ‘band-width’ and focus are a challenge and the storied investors who are on the firm’s mast-head are further and further from the new funds. That’s one problem you don’t have with a first-time fund – or with us.
Perhaps we do have something in common with those firms after all!
1 Northill Capital LLP website, March 2020.
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