Originally published by www.focuspointpress.com on August 10, 2007
When James C. Coley II, Chairman and CEO of strategic private equity investor Proctor Investment Managers, founded the company in January 2006 with its President, Mona Aboelnaga Kanaan, they wanted to evolve the emerging manager concept in a new direction.
Now just a little over 1 1/2 years later Proctor Investment Managers, or Proctor IM as Coley refers to their company, has seven affiliated firms managing over $8 billion in assets. Suffice to say, they have come a long way in a short time since they first formed the group in a management lift-out from Overture Asset Managers, a traditional asset management holding company.
Proctor IM is a strategic buyer of alternative and traditional asset managers with a hybrid business model. On one hand, by investing in the capital structure of underlying managers they are effectively a private equity group; simultaneously Proctor IM provides sales and marketing capabilities to these same asset managers. "That alone makes us relatively unique," says Coley, "there are very few if hardly any firms right now that have this kind of dual focus."
In addition, Proctor IM tends to focus on smaller asset managers. "We define emerging managers as those that typically have under $2.5 billion assets under management," explains Coley. "Those firms typically benefit most from our business model in the sense that they haven't built out a large marketing infrastructure, and therefore they can leverage their product through our sales organization."
At the same time Proctor IM seeks managers with institutional potential as well as a differentiated investment approach. "To be another fixed income or large-cap core manager is not going to cut it for us. We need something differentiated in the investment process," said Coley.
The business dynamics in the industry has also substantially changed since late 2002 when Coley and Kanaan ran the operations of Proctor IM's predecessor, Overture. Initially they thought working with hedge funds would be a great opportunity, but at the time alternative investments were generally outperforming traditional managers on an absolute basis because of the 2001-2002 bear market. Consequently, firms at the time were less willing to sell an equity stake in their operations. As Kanaan explained, "the environment at that time was quite conducive for asset gathering in the hedge fund industry."
This is not the situation now with low cost beta strategies doing well. "In the last few years hedge funds have experienced for the most part a lot of cyclical type of performance returns," according to Coley, who was also CEO of Overture. It is "very hard to differentiate themselves, hard to get product traction. That really wasn't the case back in 2002."
Proctor IM believes that the business model for alternative managers is following in the same footsteps forged by traditional managers from prior generations. "The industry is going through a maturing process, including the need for infrastructure, for management processes, and the growing need for distribution as well as manufacturing of product," said Kanaan.
"It has been a difficult environment for everybody, outside maybe the largest firms. Again if you go back to our targeted firm size, under $2.5 billion, those guys are having a real difficult time getting their message out in the marketplace," added Coley. "Things that are important to the institutional channel -- for instance, consultants, marketing support and personnel -- we can really help on that; both from our capital investment helping affiliates gain scale and add infrastructure, and secondly in the sales and marketing that we bring to bear."
The foundation for Proctor IM's business is based on what Coley and Kanaan forged with Overture. However, the asset manager aggregator model has been around for quite a while and includes the likes of United Asset Management, which was sold to Old Mutual Plc, and Affiliated Managers Group, a public company since 1997.
Rosemont Investment Partners, which focuses exclusively on making investments in asset managers who face an ownership dilemma, and Lovell Minnick, which provides buyout and growth capital to developing companies in the financial services industry, are considered competitors of Proctor IM. Another player is Asset Management Finance, led by Norton Reamer the founder of United Asset Management. His company offers a patent-pending structure that provides up-front capital in exchange for an expiring interest in an asset manager's future gross revenues. Interestingly, several of these firms, including Proctor IM, are backed by the some of the same banks.
As Coley stated, "the business model is going through an evolution," which is to be expected. In response, Proctor IM looks at the various aspects of firms such as Neuberger Berman, Affiliated Managers Group, Nvest Companies and Legg Mason and borrows what it considers best practices.
Proctor IM's value added to its affiliates is broader than just financing and distribution. Once they engage with an asset manager, the entire management team goes through an extensive process in which sales is just one part of the equation. Making sure the messaging is correct, working on the presentation, contact management administration and client servicing all play into the rollout strategy, which includes public relations. These are all important and relevant steps prior to the blocking and tackling of the actual sales process and facilitating investors through the pipeline.
"It's everything you want from a firm if you want to do it in-house. We customize for each asset manager depending on how much they have internally that they want to do, versus what they would rather us work on for them," says Coley. "Each firm has different needs."
To date Proctor IM has partnered with a variety of asset managers. These include Aletheia Research and Management, a $6 billion large-cap manager; Atlantic Capital Management, a traditional growth manager with $668 million in assets; Avatar Associate which manages $1.2 billion in a quantitative tactical asset allocation strategy; Boyar Asset Management, a $565 million deep value intrinsic manager; and Drake Asset Management, a long-short global equity hedge fund with $189 million in assets. Additionally, Proctor IM has stakes in Explorer Alternative Management and just negotiated a deal with Conquest Capital Group (see links for articles on these two affiliates).
"The reason we do this is that from a sales perspective, getting through the clutter of calls with the consultants and institutional clients, it is important for us to have something we can get across very quickly and in a succinct message, if there is a fit," Coley says.
This also plays into why Proctor IM is seeking to put together a stable of asset managers that it considers differentiated and complementary. As can be seen, Proctor IM is building relationships which incorporate both alternative and traditional investment managers under its umbrella.
Proctor IM does not provide consolidation of backoffice operations, however. According to Coley, "At one time at Overture we thought that would be part of our business strategy. But what we ultimately found is that unless all the firms are located in the same geography, which we don't insist on, backoffice consolidation can be difficult."
Coley goes on to say, "More importantly that is a business of tremendous scale. There are just a whole host of people that can do a better job than we ever could do." In view of that, Proctor IM will help their affiliates, who make their own decisions ultimately, outsource to selected vendors with preferential pricing, whether it be performance reporting or legal services.
A key and early on strategic decision that immediately increased the pipeline for potential private equity transactions was expanding Proctor IMs business model to allow for minority stakes. As Coley explained, "It really opened up the opportunity set, particularly on the alternative side. We won't say that we won't do a majority stake but we don't insist on it anymore."
"Asset management is a great business to be in -- great for growth, high margins, certainly smart people, empowerment. But you have to recognize the uniqueness of this industry. We do not believe that you can treat it similarly to other industries that have been quite well invested with private equity capital," Kanaan says.
Accordingly, the way Proctor IM sources and structures their deals is specialized to the industry. "You have to be cognizant of the fact that this is very much a people business; you have to structure deals in true partnership fashion," explains Kanaan. For that reason Proctor IM cedes the day-to-day decision making with the asset management team. Proctor IM is, however, a partner with a direct stake in the capital structure, and therefore maintains a seat on the board with direct involvement in the strategic direction of their affiliate asset managers.
In seeking to identify complimentary rather than competing investment strategies, Proctor IM leverages their network in an effort to find promising managers. They also receive regular inquiries. "We are certainly eager to increase the number of deals beyond were it is today," says Kanaan. "When managers are at that boutique stage, which we think is anywhere from $100 million to $2.5 billion, Proctor IM provides an opportunity for these asset managers to supercharge their growth without necessarily having to grow the infrastructure all themselves."
According to Kanaan, Proctor IM has an integrated approach for looking at deals from a private equity perspective -- making sure that deals are a valid and attractive investment, as well as making sure the products are marketable to the different distribution channels. Key to this process is Proctor IM's management team of fourteen professionals of which eleven are dedicated to sales and marketing. Their combined knowledge of the various institutional channels and investment requirements improves the vetting process of prospective asset manager deals.
Proctor IM doesn't have that many hard boxes to check. What is most important is the credibility of the people and whether or not the business is institutional because that is the marketplace they are completely focused on. If the business is not run properly or if there is no defined investment process, then it is probably not a good fit for Proctor IM.
"We try to look at the way they managed their money, their business management. We don't do it based on timing or chasing trends. Like a private equity deal, it is based on backing a team," says Kanaan. "What ultimately makes Proctor IM unique is the differentiation between the affiliate asset managers we are aggregating, their individual stories, and what they are doing."
In order to finance these transactions, Proctor IM got their working capital to build the business out and purchase investment companies from a subsidiary of National Bank of Canada.
"It is a long process to build one of these businesses from scratch. As you can imagine there are a lot of moving parts." According to Coley, "The economics of the business is, such that till you realize, if you ever realize, a property in your portfolio, that the cash flow is really determined off the distribution economics of the partnership."
The business itself creates a conundrum. "You can't get product without sales people, and you can't get sales people without product," says Coley. "There are several business drivers, and partnerships can take years before they get very profitable."
The asset management industry has developed considerably since the turn of the century, not to mention how quickly alternative investments have grown since the early 1990s. This has not happened, though, without a fair share of concerns materializing.
There is currently an ongoing debate that, as hedge funds become more institutionalized and crowded alpha is getting squeezed, and in line with the efficient market hypothesis, evolving into leveraged or exotic betas. "It is very hard to find in the current market environment significant alpha producers," says Coley. He thinks, however, this is totally related to volatility. "All we have to do is wait for one of these fat tail events."
"I am absolutely convinced that the industry is going through a major monumental change in that it is following exactly what happened in the long-only space, and that is because volatility is falling," explains Coely. "I don't think it is because people are less skilled. When volatility gets compressed and it stays relatively low, skill becomes hard to see. If the market where ever to return to normalized volatility, which some day I'm sure it will, then the band between someone who is very good versus someone who is not so good will open up and you will have 'alpha' again."
Proctor IM is well-positioned to identify upcoming talent through an affiliate called Explorer Asset Management, which was spun out of Circle T Partners. Explorer offers a multi-strategy product that invests with hedge funds vis-à-vis sub-advisory agreements though a managed account platform. The fund clears through a single prime broker and the main advantage of this structure is that it provides both liquidity and transparency into the trading.
As can be imagined, Explorer creates a watch list of managers Proctor IM might want to get to know better, but are a little too early in the curve to meet its direct investment parameters. "It is a very unique product for institutions and consultants looking for a first foray into hedge funds, but don't want to have the illiquidity or more importantly the lack of transparency," says Coley.
In another recently inked deal, Proctor IM acquired an equity interest in Conquest Capital Group, a managed futures shop based in New York. Conquest has done research which defines beta in the sub-sector as the opportunity set of "all the trades" in managed futures. Then through a quantitative model they replicated the trading, which provides a relatively high degree of correlation to the beta of that opportunity set. Proctor IM recognized that Conquest's process of creating 'beta' can actually be carried from, not just managed futures, but to other strategies.
"Go back a couple of decades ago to the evolution of index products and ultimately index plus. What that did was basically revolutionize the asset management business," says Coley. "It comes to separating who are really beta managers and who really are alpha managers."
Coley's view on alpha and volatility is only a prelude to his main thesis. "Problem has been, as I said earlier, in defining beta," making his point. "So once the industry has come to a real definition of beta, which in my opinion will come through products as opposed to some research breakthrough, investors are going to begin to demand [such products] like they did in the long only space. 'I am only going to pay for beta or exotic beta, but if you provide alpha I will pay 2 and 20.'"
"If you are really going to provide 'beta' than you better provide beta and hug a bunch of markets or benchmarks returns, and for a very low fee. And if you are truly going to be an alpha manager then we now have ways to measure that and we are willing to pay for it. And I think that is what is going to happen to the hedge fund world," Coley concludes.
For Kanaan, however, the business philosophy is rather straight forward, "If these managers are worth placing money with to manage, why not invest in the asset management business itself."
This article was written by Michael "Mack" Frankfurter and first published by Focus Point Press, Inc. (Emerging Manager Focus) under the title "A Lift Out Legacy Gives Proctor Business Acumen when Selecting Viable Managers." It is republished here by permission.