Tuesday, 21 February 2017
Last updated 55 min ago
Feb 24 2011 | 11:49am ET
As Joe Schlater tells it, he was sitting at his desk one day at Morgan Stanley, where he specialized in high-net worth families, family offices and institutions, when he got a phone call from one of his institutional clients.
“They said, ‘Look, we’d like to start allocating more... to minority-owned firms.’
“And there I am,” says Schlater, who is African American, “at Morgan Stanley—clearly not minority-owned—and I say, ‘Okay, good luck, we wish you the best, see you”
But the client doesn’t let it go.
“He said, ‘We’d like you to help us out,’” says Schlater.
Schlater, laughing as he tells the story, says, “So I said, ‘You want me to teach people like me how to take business away from me?’”
And then he decided to help.
His first call, says Schlater, was to Progress Investment Management’s Marx Cazenave, whom he’s known for 25 years. Progress is the largest long-only, minority-owned fund of funds in the business, founded in 1990 by Cazenave and Ed Callan. Today, it has about $7 billion in assets under management. Cazenave is now retired, but with his experience in the emerging manager space and “tremendous connectivity,” Schlater considered him an obvious source of information.
But his search for intelligence on emerging managers, a space he confessed to knowing little about at the time, didn’t end with Cazenave. Schlater says he began to reach out to “the usual suspects”—smaller broker-dealers and asset managers—trying to learn what he could.
Around that time, Schlater gave a presentation for his client at a forum for minority-owned firms. It was here he had what he describes as an ‘Aha’ moment.
“I’m looking around the table and it’s pretty much long-only, fixed-income,” says Schlater. "I was kind of shocked to see that they were somewhat behind the curve of where I was at Morgan—I was doing more allocations to hedge funds and private equity.”
Hesitant About Hedge Funds
He wondered why institutions, like his client, were either under-allocated (or un-allocated altogether) to hedge funds. Still working at Morgan Stanley in 2007, he began researching the question. “And the number one thing that popped out,” he says, “was ‘lack of transparency.’”
Number two, he says, was the “culture divide” that existed between the hedge fund community and state funds. “A lot of hedge funds would not go through an RFP or an RFI process” says Schlater. Managers, he says, seemed to think, “Why should I go through this process if I can just raise money at a family office, if I can raise money at the country club?”
What struck Schlater particularly about hedge funds as an asset class was that “up until that point, it had never been institutionalized.”
“Long-only equities, long-only fixed-income, even real estate, all got institutionalized first, and then scaled to individuals second. This was the only asset class that I’ve ever seen that was high-net worth family office first and yet to be institutionalized.”
And from this realization and his research into emerging managers, a business idea was born.
Schlater found himself sharing his findings with Cazenave, “I said, ‘Look, I would really like to do something like you did at Progress, I would like to do it around the emerging manager space, I think, and I emphasize that word, I think there’s talent, [I’m] not sure but there’s enough research that we’ve done that gives me a certain amount of confidence to move forward.’”
Cazenave told him the first thing he’d need was the right people—so Schlater immediately tried to recruit a partner he felt would be perfect: Cazenave.
The Progress founder came aboard as a shareholder and board member ensuring, says Schlater, the Cazenave “brand” was aligned with Busara Advisors.
Then, in 2008, Schlater met Andrew Timpson. Timpson had been a managing director in RBC’s alternative assets group but, coincidentally, had quit the week before meeting Schlater.
“I was at RBC from ‘95 to 2008,” says Timpson, “I spent about five years in a risk management role in the middle office there looking after trading strategies that the bank traded on a proprietary basis as well as looking at hedge funds from both an investment perspective and a counter-party perspective. At the time I left I was the managing director in charge of all research and due diligence for a $10 billion portfolio of hedge fund investments.”
While much of his work was due diligence and research, he also had portfolio management responsibilities on certain pools of assets, and that was the part of the job he found most interesting.
“Really,” says Timpson, “my reason for leaving was I wanted to do that on a full-time basis.”
He looked at joining some existing fund of funds firms but wan't particularly excited about that. What he wanted, he says, was to do something entrepreneurial, particularly in the emerging manager space.
“I think, particularly when dealing with institutions, that is where you can really add some value. Many of the big institutions are going direct as well and investing with a lot of the big, well-established hedge fund firms, and, my view was, they don’t really need any help doing that.”
Statistically, though, emerging managers have shown “some pretty significant out-performance,” he says—including smaller firms, newer firms and even, some evidence suggests, minority and woman-owned firms.
Hedge Fund Research released a report this month showing hedge funds run primarily by women and minorities have bested industry averages by a wide margin—particularly in 2008. In that year, the HFRX Diversity Index, which includes hedge funds that are majority-owned by women or minorities, lost just 5.41%; the average hedge fund lost more than 20%.
“Intellectually,” says Timpson, “that’s just much more interesting and challenging and we did a fair amount of emerging managers when I was at RBC, so that was an area that I was just very interested in.”
Schlater and Timpson assembled an advisory board that includes Marx Cazenave, Pat Gerrick (former chief investment officer of the North Carolina Retirement System) and Issac Vaughn (CEO of SC Investment Consulting) and acquired another Morgan Stanley alum, Elizabeth Havens, as a partner. They also found a platform for their operations (an engine for a fund of funds that was spun out into a separate business), and all that remained was to choose a name.
Timpson says the name was one of the first issues they attempted to deal with when he got involved in the project in 2008, but finding a name that “really represented what [they] were doing” proved difficult.
“One of our lawyers said should avoid nouns,” says Timpson, “because most of them are taken, and someone else suggested we just avoid the English language entirely. Ironically, that turned out to be the best advice we got.”
The salient facts about the new firm, in Timpson’s mind, were 1) that it was minority-owned; 2) that it focused on hedge funds, particularly emerging managers; 3) and that it was interested in transparency, right down to the portfolio position level.
Having, by now, decided to “abandon the English language,” Timpson says it occurred to them that as they were predominantly an African American-owned firm, perhaps they should consider an African language. Timpson’s wife found a good online English/Swahili dictionary and they began to consider Swahili names.
As they were searching, the Madoff scandal broke in all its grisly details—including the fact that many funds of funds had invested with him. “I had reviewed many Madoff feeders over the years and based on commonsense alone and some pretty obvious factors had identified a lot of red flags,” says Timpson. “So we kind of kept asking ourselves, ‘Where’s the commonsense? Where’s the wisdom?’”
Turns out it was in the Swahili dictionary under ‘b’ for ‘busara’—a Swahili word that translates as "wisdom, good judgement, commonsense."
America’s Got Talent
The name settled, it was time to address what Schlater calls “the last missing ingredient.” While Busara’s definition of “emerging” hedge fund managers includes smaller firms, newer firms and minority/woman-owned firms, they found themselves being asked the same question over and over by potential clients.
“Do we have talent as it relates to minorities and women?”
In February, they slowed their marketing efforts and set out on a “sourcing spree” that would last until August and produce a database of over 200 minority/woman-owned hedge funds. (The largest database of its kind, Schlater believes).
“For me,” he says, “it was probably the most inspirational process of building this business because the talent that we met and the people we were engaged with was actually far beyond what I thought we would see.”
Busara is based in New York, so they use New York State’s definition of a minority or woman-owned business, which means the company must be owned by a U.S. citizen or permanent resident and 51% or more must be owned and controlled by either a woman or an ethnic minority (African American, Hispanic, Native American or Asian American, including the Indian sub-continent.)
“People don’t necessarily know how widely defined it can be,” says Timpson. In fact, they met money managers who didn’t realize they qualified as minority- or woman-owned. One woman they spoke to said, “I’m 54 years old and I’ve just discovered I’m a minority.’”
Timpson says they gathered much of their information by word of mouth: “I’ve been in the industry for a long time so, [I was] literally, talking to everyone I know, ‘Who do you know that fits this description?’
“Typically what would happen when we asked a group of people, they would give us two or three names and then over the next two or three days or weeks, additional names would kind of trickle in as they’re…talking to someone [and realize], ‘Oh wait, this guy meets the description’ or ‘This woman would be a candidate.’”
The rest he describes as “really just hard work, grunt work, rolling up the sleeves and going through databases… We had a couple of proprietary ways that we screened for names and tendencies and then just made phone calls and some were hits and some were misses.”
And sometimes, the search process could be awkward. As Schlater says, people who manage hedge funds like to be known for their numbers, not their status as a minority or a woman. Some worried that trumpeting their minority- or woman-owned status smacked of a sense of entitlement. But Busara had an answer for that, says Timpson:
“Our view is, the only thing you are entitled to is a fair opportunity.”
Today, Schlater and Timpson are talking to state funds with mandates to invest in minority- and woman-owned funds and considering which funds from their 200 plus-name database actually suit their needs.
They’re not running a commingled fund but are creating customized portfolios of hedge funds, so determining exactly what potential clients require is important to “get assets and managers in the door and to customize products that really fit [clients’] liking,” says Schlater. Busara’s overall portfolio management approach incorporates both top-down and bottom-up factors.
Timpson says in terms of manager selection, Busara’s approach is “traditional, bottom-up, fundamental analysis” combined with a “heavy due diligence focus on both the operational risk side as well as the portfolio management side.” In addition, he says they require “complete transparency from underlying hedge funds on at least a monthly basis, which is a key component of our portfolio and risk management process.”
With respect to minority and woman-owned funds, He says having over 200 funds in the database doesn’t mean they have over 200 funds they’d “invest in tomorrow.” Some, he says, he would stay away from because they don’t have the necessary operational controls in place, others because of strategy. Another big factor, he says, will be the client’s mandate and risk profile.
Schlater says those potential clients include, as mentioned, state funds, the defined benefit plans of corporations with diversity polices (a list he says is long in the United States) and finally, a somewhat unexpected source: international investors interested in doing business with minority-owned firms.
“Basically,” says Schlater, “the election of President Obama changed the minority face of America and certain people—in the Middle East, primarily—have said, ‘We would like to do business with more people like him.’”