When people ask me why I am such a passionate advocate for emerging managers, I sometimes wax a little poetic. But the fact is, after nearly 17 years in the alternative investment industry, I don't believe any investor can have a truly optimized or truly diversified portfolio without allocations to young, small, women and minority-run funds.

With 90% or more of asset flows going to the "billion dollar club" managers, it would certainly seem others don't share my enthusiasm. However, when you look at the different types of alpha, it seems clear why emerging managers should get more than a fair shake. I'm not advocating avoiding large, successful funds. But by ignoring emerging managers, investors risk removing two important types of alpha from their money management arsenal. 

 (c) 2014 MJ Alternative Investment Research

(c) 2014 MJ Alternative Investment Research

With any size or age fund, or within any manager demographic, it is possible to find funds where alpha is generated by luck. The saying "even a blind pig can find a truffle" exists for a reason. Likewise, there are very skilled managers available in each of the groups above. The cyclicality of investment strategies mean that alpha can be generated by emerging managers in any strategy if market conditions are right. 

However, when it comes to structural alpha and cognitive alpha, the rubber hits the road. Structural alpha is created when a fund is young and small enough to be nimble, niche-y, under the radar, concentrated, etc. It would be extremely difficult, if not impossible, for a fund in the "billion dollar club" to exhibit these traits. Cognitive alpha, where a fund generates higher returns because the manager thinks and acts differently than the herd, isn't unheard of in the "billion dollar club," but it is exceedingly rare. Think about how many minority or women fund managers you know with more than $1 billion in AUM. 

Small and young funds may exhibit structural alpha and they are also more likely to have diversity managers at the helm that can contribute cognitive alpha. Women-run and minority-run funds may exhibit cognitive alpha, and they tend to be small and/or young funds, so may also display structural alpha. With alpha supposedly an endangered species in today's investing world, can investors really afford to ignore emerging managers? 

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AuthorMeredith Jones