CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

CHAPTER 9

Fund Manager Selection Process

While a wide divergence between top- and bottom-quartile performers (see Exhibit 8.1 in the preceding chapter) may provide an opportunity to perform extremely well by selecting top-performing managers, it also exposes the portfolio to a high degree of underperformance risk. And if an institution is unlucky or unskilled enough to pick a bottom-quartile manager, the returns will likely prove to be very disappointing.

Manager selection and access are seen to be among the keys to sustainable outperformance in private equity (PE), forming a distinct part of the investment process that can be efficiently structured. Manager selection is not mechanical but requires industry experience and resources to conduct both research and due diligence. Unfortunately, this is easier said than done, and the advice to focus on top funds is probably as helpful as the observation that to become rich, one needs to acquire a lot of money. Further, it is more difficult to identify superior managers than it is to weed out obviously inferior managers. The key is to be highly selective and to strike a proper balance between seeking exposure to top funds and diversifying. Thorough consistent, detailed analysis and discipline in the due diligence process are critical.

To make matters worse, few investors, advisers, and consultants have experience and familiarity with the unique aspects of private equity. Because the industry and its practices are continuously evolving, ...