Choosing the right investment manager is critical for achieving above-average returns in private markets. The gap between top-tier and underperforming managers can be quite large. This is particularly true in private equity, where top funds often outperform poor-performing ones by 15% to 20%, per year. This wide range of outcomes makes picking the right manager even more important.

To make well-informed decisions, investors must conduct comprehensive due diligence before selecting a manager. This article introduces the ROYC approach, a sophisticated research methodology we have refined over two decades. Our framework serves as a guide for this crucial selection process, offering a strategic advantage in navigating the complex landscape of private market investments.

1. Initial Screening of Investment Universe

Our process begins by screening the approximately 30,000 fund managers worldwide, focusing on those with a history of above-average returns. This initial filter allows us to concentrate our in-depth research on managers who meet the high standards required for ROYC client portfolios.

Not only do we focus on managers with proven histories of above-average returns, but we also ensure their investment strategies align with the current economic backdrop. It is essential to target managers who have successfully executed strategies that fit our investment thesis for the current economic cycle. For example, we tend to prioritize mid-market and sector-specialist buyouts, ensuring our investments are not only with top-performing managers but also in strategies positioned to thrive under all economic conditions.

2. Finding and Initial Review of Opportunities

Once we have identified a subset of managers (typically numbering in the hundreds) with compelling performance histories and investment strategies that align with our in-house view, our due diligence process begins. The initial step leverages our extensive network of industry professionals to focus on opportunities that are:

   i. Institutionally backed.

   ii. Promising in terms of potential returns

   iii. In high demand among sophisticated investors

This approach allows us to further refine our selection, concentrating on managers who not only have strong track records but also possess the institutional support and market recognition that often come with sustained success.

3. Detailed Examination

After identifying promising opportunities, we initiate a comprehensive evaluation process. This rigorous examination encompasses both quantitative analysis and qualitative assessment, ensuring a holistic understanding of each potential investment.‍

a) Organization

• Experience and Stability: We check the experience and stability of the investment team. A strong team with a history of working well together increases the likelihood of consistent performance.
• Alignment of Interests: We ensure the team’s interests align with investors by looking at how profits and performance fees are shared. This alignment is crucial for ensuring that the managers are motivated to perform well.
• Employee Turnover: We contact former employees to understand their reasons for leaving. High turnover can indicate internal issues that might affect performance.
• Key Personnel: We analyze the returns attributed to senior professionals to assess any risks associated with key individuals. This helps us understand how dependent the fund is on certain key players.
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b) Investment Strategy

• Evaluation: We evaluate the proposed investment strategy, including target size, sector, region, and type of investment. Understanding the specifics of the strategy helps us assess its potential.
• Strategy Comparison: We consider how the current strategy differs from past strategies. Changes in strategy need to be well-justified and align with the current economic context.
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c) Track Record

• Performance Review: We review performance over the past 10 years, both realized and unrealized. This helps us gauge the manager’s consistency and reliability.
• Capacity Management: We assess the manager’s capacity to manage existing investments while taking on new ones. Ensuring that the manager is not overstretched is key to maintaining performance.
• Benchmarking: We compare the manager’s performance with peers using key figures like Internal Rate of Return (IRR), Distributions to Paid-In Capital (DPI), and Total Value to Paid-In Capital (TVPI). This benchmarking helps us see how the manager stacks up against industry standards.
• Consistency Analysis: We analyze how consistent the manager’s investments and returns have been. Consistent performance is a good indicator of reliable management practices.
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d) Operational Setup

• Business Continuity: We check the manager’s business continuity plans, internal processes, cybersecurity measures, ESG (Environmental, Social, and Governance) risk management, and overall governance. A solid operational setup is essential for long-term success and risk management.
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e) Legal

• Document Review: We review legal documents to ensure they meet market standards. This step is crucial for protecting our investments and ensuring that the terms are fair and reasonable.

4.  Investment Committee

The ROYC investment committee is integral to our decision-making process, creating a continuous feedback loop throughout the evaluation. At various stages - including finalizing investment decisions - the committee reviews and votes on the opportunity's potential. This iterative approach allows for:

   i. Regular reassessment as new information emerges.

   ii. Incorporation of diverse perspectives from committee members

   iii. Adjustment of evaluation criteria based on ongoing insights.

   iv. Refinement of the research focus in response to committee feedback

This review process ensures that decisions evolve with our understanding, fostering well-informed, thoroughly vetted investment choices.

5. Execution and Monitoring

The final stage involves executing the investment and ongoing monitoring. Our process includes extensive legal due diligence and term negotiation. Through our advanced ROYC digital platform, we deliver timely updates to investors, including detailed reports and important notices.

The ROYC investment team maintains consistent communication with fund managers and participates informal meetings. We then distil and share these valuable insights with our investors, fostering a transparent and efficient investment process.

Conclusion

Thorough research demonstrates an investor’s commitment to making informed decisions. By combining detailed screening, in-depth assessments, and continuous monitoring, investors can make well-informed decisions that enhance potential returns. This meticulous approach not only targets superior performance but also instils confidence, assuring that investments are managed with expertise. By aligning our due diligence process with the current economic landscape, we ensure that our investment strategies are both robust and relevant, maximizing the potential for success in an ever-changing market environment.