Stonehaven’s Manager Evaluation Criteria

By Mark Sullivan, CFA   |  Managing Director & Partner, Stonehaven, LLC

Stonehaven’s ability to source, evaluate, and partner with asset managers that have a high likelihood of raising capital, retaining that capital, and producing strong risk-adjusted returns is paramount to our success.  Today’s capital raising environment is absolutely one of the most challenging in the history of the alternative investment industry, and the resources required to mount an institutional caliber capital raising campaign are immense.  As a result, Stonehaven has spent considerable time codifying the qualities we believe are most likely to predict capital raising success into a consistent process aided by an internal scorecard framework.  Not surprisingly, these qualities are highly aligned with those sought by the allocator community, augmented by the fact that we enter into intensive day-to-day operating relationships with our managers and rely on their business success as well as their investment success to achieve our goals.  So, what do we believe are the critical success factors to raising capital?

• Strategy: We are generally agnostic with respect to investment strategy.  We have partnered with firms across many strategy segments, from mainstream long-short equity to very niche offerings.  The reality is that the allocator relationships we maintain have broad interests.  Not every investor is open to every strategy, but as a group our relationships possess appetite across all strategies. We also don’t let the demands of today dictate the strategies that we seek.  Our relationships with managers are very long, and what’s hot today will change tomorrow.  All this being said, we often engage in research projects to seek out opportunities in specific areas where we think there could be outsized opportunities.   Regardless of the strategy, we seek out mangers that are producing differentiated and sustainable alpha with the least amount of beta possible.  We seek managers with a clear edge and repeatable process that is sufficiently unique among their peers.  After all, Stonehaven will only be successful raising capital if a manager provides a sufficiently unique value proposition to the marketplace that can be clearly articulated and demonstrated consistently over time.
• Track Record: Track record is perhaps the most easily observable qualifying factor, and as such we, like allocators, seek managers with a strong historical track record. We prefer managers with at least two years of track record in their current firm, with some flexibility for experience from previous firms.   In addition to length of track record and risk-adjusted returns, attention must also be paid to critically evaluating historical alpha and beta attribution drivers.  We use proprietary models for this process and spend considerable time understanding both periods of strong performance and any historical hiccups.  Current average returns in the alternative investment industry are unacceptable, and managers consistently producing those low single digit returns (and worse) deserve to face considerable redemption or fee pressure.  Only a small subset of the manager universe will break away from the pack with strong risk-adjusted returns, and our ability to identify those managers is critical to our ability to raise capital.
• Team: The strongest organizations have deep and pedigreed investment and operational talent, with aligned interests and a long history of successfully working together. We consider the quality and culture of the current organization as well as the management team’s history building and managing past organizations.  We also believe that it is important to look beyond the top principals of the business.  In times past, managers could start with 1-3 principals, raise moderate amounts of money, and bootstrap teams together as they grew.  That is no longer the case.  Today, managers need to make a significant upfront investment in their team to raise institutional capital.  Unfortunately, many managers severely underestimate the need for such investment, as well as how easy it is to spot an inadequately staffed organization.   Just as important as the absolute size of the staff is the incentives provided to align all involved, including the investment, operations and marketing staff.  Culture is key, and we seek confident but humble personalities among firm leadership. Turnover in small organizations is a distraction, extremely damaging to sentiment and raises many questions with the watching allocator universe.  Hence it is absolutely critical to insure stability through appropriate culture and compensation structures.
• Profile: Closely related to the team category, our analysis of profile focuses on the story of the firm and principals. What is the level and make-up of their asset base?  How much capital does the GP have invested in the strategy?  What strategic relationships do they possess as a firm?   Needless to say, a critical level of assets is important in order to attract additional capital and to prove out the viability of the strategy and track record.  However, capital alone does not beget more capital.  So while we, like most investors, prefer a critical level of AUM to enter a relationship with a manager, we also look at the quality of the capital and what it symbolizes.   A strong GP commitment is a condition precedent, whether large on an absolute basis or relative to their net worth.  It is “skin in the game”, but more to the point it is the clearest display of psychological commitment and belief in the business.  Similarly, important insights can be gained from endorsements from key relationships such as a seed partner, former employers & colleagues, past investors, service providers or other notable industry persons or organizations.  Endorsements come in the form of the capital commitments, but also other resources such as office space, personnel, branding, references, affiliations, joint ventures, etc.   As we always say, if a manager can’t get their strongest relationships to back them in some way or another, how can they expect an allocator who is just now developing a relationship with them to get comfortable?
• Infrastructure: It can’t be overstated how critical it is for a manager to display business strength. We seek managers who focus significant resources on running an institutional business with an emphasis on adopted industry best practices, robust infrastructure and transparent integrity.  Is there sufficient non-investment know-how in the form of strong C-level executives?  Is there an appropriate separation of duties?  Is there a comprehensive, tailored compliance regime?  Are there red flags or outside distractions that conflict with or hinder the business?    We feel that for a manager to be appropriately positioned to excel as a business, their firm must be firing on all cylinders, be free of issues, and have no points of hindrance or weakness.   Accordingly, attention must be paid to making sure that all the non-investment functions of the firm result in a smooth operation.   Allocators demand robust infrastructure and a culture of compliance to make sure their assets will be safe from fraud, but also so that business hiccups don’t act as a distraction to the investment side of the house.    We also look for other red flags that may signal weak business integrity.  On this front we examine whether the manager’s location is appropriate for the execution of the strategy, building a business, and developing relationships with investors, or is it self-serving to the manager.  Past regulatory issues and professional baggage, or failings can also provide insight into business integrity or foreshadow future behavior.
• Capital Raising: Beyond all the factors discussed above, a manager must productively engage with the allocator universe in order to be successful. To that end, we seek managers that embrace the marketing process.   For us this requires 1) a Positive Marketing Disposition, which includes what is required today to effectively connect with and appeal to the allocator universe; and 2) a Positive Partnership Disposition, which is what is required for an effective collaborative relationship with a strategic marketing partner.
• Positive Marketing Disposition: Managers today must be open to and have an appreciation for frequent, pro-active, and transparent communication with current and prospective investors. This does not necessarily mean daily position level transparency, but rather an overall attitude of openness that allows the allocator audience to understand the manager’s thought process for employing their investment strategy and managing their business.  Marketing materials and digital presence must be highly polished and consistent, as inconstancies, loose ends, or general opaqueness raise questions and lead to unease.  Managers must also make themselves highly available and possess strong presentation skills that convey knowledge, comfort and passion.  They must also embrace the very long duration of the sales cycle even for the best positioned managers.  From our experience closing over 2,000 placements, approximately 25% of placements occur in under 8 manager interactions, approximately 50% between 8 and 12 manager interactions, and 25% require over 12 manager interactions.  Alternative asset management is a people business, and investors want to have genuine relationships with their managers.  Managers who misunderstand this, and display aloof or impatient tendencies toward the marketing process, may find it difficult to build their business.
• Positive Partnership Disposition: The nature of our business is such that we manage long term, collaborative, strategic and tightly integrated capital raising relationships. To do so, we seek managers, who embrace our significant input related to marketing strategy, sales process, material content and design, communications strategy, team development, business strategy, and systems and service providers.  Given we maintain active relationship with a very broad set of investors, we seek comprehensive relationships with managers that view us as true long-term partners.  It only with a comprehensive, total market approach that we can justify making the significant investments necessary to successfully execute on helping the manager realize the full vision for their business.

The wide range of criteria considerations laid out above require Stonehaven to cast wide net sourcing opportunities, dig deep with our diligence, and select manager relationships very carefully.  We are only actively raising capital for a relatively small number of long duration manager relationships at any given time, so we only seek to add 1-3 new manager relationships annually.  If you or somebody you know could be a good potential partner, we would welcome the opportunity to open up a dialogue.