Opinion: Adding the value of small managers

For investment advisors ready to move from theory to practice, there are established best practices behind the prudent implementation of allocations to smaller funds and fund managers.

Valuable business development considerations

In crowded markets where large managers pile into the same trades, smaller funds remain one of the few areas where genuine alpha is still achievable — often with exposures uncorrelated to core portfolio holdings and less risk. These smaller managers are likely to enhance performance, diversify risk and expand your toolkit.

They can provide advisors with competitive differentiation. Most portfolios look remarkably alike because they source from the same limited manager universe. A purposeful allocation to smaller funds can set your results and manager recommendations apart, something that clients will appreciate.

And smaller managers have skin in the game. Your allocation can be a relationship, not just a transaction. That can translate into better access, through separately managed accounts, niche strategies, co-investment opportunities and priority on capacity or partnership arrangements.

Allocating with purpose

A structured, consistent approach will neutralize many of the perceived risks associated with non-household-name managers. More importantly, this will position you to capture the performance and diversification benefits that smaller funds can deliver — while enhancing your value as an advisor.

Step 1: Clarify your thesis. Define why smaller funds belong in your recommendation set — as alpha generators, diversifiers or risk mitigators. Be explicit: absolute return, lower correlation, specific sector expertise or targeted volatility reduction.

Step 2: Expand your sourcing pipeline. Move beyond the usual large-manager databases. Consider firms like Global Manager Research, industry associations such as the Canadian Association of Alternative Strategies & Assets, relevant conferences, curated LinkedIn groups, peer networks and referrals.

The best opportunities often come through non-traditional channels. They are out there.

Step 3: Adapt due diligence for scale. Maintain standards but flex your process. Smaller managers may not present data in your preferred format immediately. But the good ones have robust information, strong track records and deep expertise.

Credentials matter. For example, a former corporate bond market-maker with both chartered accountant and chartered financial analyst designations may run a proven credit fund worth considering.

Step 4: Right-size allocations and mandates. Structure allocations meaningful to managers but aligned with your client’s risk profile and liquidity needs.

Consider scaling in over time. Prioritize differentiated managers with niche advantages and explore creative structures such as revenue sharing in select mandates or opportunistic co-investments.

Step 5: Integrate into governance. Document your smaller-manager strategy. Establish reporting and transparency requirements up front.

Review liquidity terms, gating, valuations, subscription mechanics and distribution policies. Commit to regular reviews, site visits and commentary assessments to manage risk effectively.

You don’t have to overhaul your entire process to benefit from including smaller funds.

Five approaches

This is not an exhaustive list, but in terms of the mechanics of bringing on a smaller asset manager, consider these tactics.

1. Complement or replace an existing holding. Swap part of a traditional allocation with a smaller fund that has delivered persistent outperformance with equal or lower risk. Five per cent more per year in fixed income, for example, is a lot.
2. Target an absolute return allocation. Strengthen risk/return by inserting a smaller manager with complementary characteristics and demonstrable absolute return benefits.
3. Bolster alternatives. Slot smaller funds into the 20%–30% alternatives allocation when they serve a defined role.
4. Create a dedicated sleeve. Package smaller fixed income, hedge or venture funds into dedicated sleeves to capture alpha while diversifying risk.
5. Pilot through small carve-outs. Gain experience with a new manager with a 1%-2% allocation before scaling.

Done correctly, these strategies are likely to deliver value, for you and your clients, no matter the market conditions.

Kevin Foley is managing director, institutional accounts, at YTM Capital Asset Management. He spent more than two decades in capital markets at a Canadian bank and serves on several foundation boards. He can be reached at kevin.foley@ytmcapital.com.