Ashby Hatch, Head of Global Investment Research, discusses Cambridge Associates’ investment due diligence process and how the firm is pivoting in this new environment to continue to find and access best-in-class investment ideas around the globe.
THE SHUTDOWN IN MARCH CAME ON RATHER ABRUPTLY. HOW DID THAT IMPACT YOUR ABILITY TO CONDUCT MANAGER DUE DILIGENCE?
AH: Initially, when travel suddenly halted and businesses went remote, we focused on prioritizing the managers already in our due diligence pipeline. Our robust pipeline going into the global shutdown enabled us to focus on investment opportunities where we had already begun to engage. These were generally firms where we had existing relationships or knew the principals from their prior firms. There was an assumption we could pivot to brand new ideas once conditions cleared up and the existing restrictions began to ease.
AND THEN YOU REALIZED THAT THE “NEW NORMAL” WASN’T GOING TO BE AS TEMPORARY AS WE INITIALLY THOUGHT.
AH: Right. As we realized we would be diligencing and researching new managers that we had not met in person, we evolved our processes. We enacted new steps to compensate for not conducting onsite meetings. Our team mapped out how processes would need to change to ensure the criteria needed to develop conviction stayed firmly at the high bar we set in our normal, “face-to-face” world. To fully vet managers, we needed to create that conviction through different means of interactions.
WHAT DO THOSE DIFFERENT MEANS OF INTERACTION LOOK LIKE?
AH: It involves more thoughtful and purposeful interactions. Our normal process is to conduct onsite or in-person meetings that may last all day and cover a wide variety of topics. In the virtual world, the frequency and format have changed, agendas are more formalized, and calls may go deep on one topic at a time.
We are also expecting an increased team presence from the managers in our interactions. In an in-person meeting, some key members may be traveling or out of the office. In the remote world, we want to see the team in totality. We require all key personnel to be visible and available on calls, and this environment makes that more feasible.
We have also enhanced our requirements on reference calls and are working our industry networks and back channels more intensely. Without live meetings, our interactions with managers are going to be two dimensional. We are relying more on what that manager has done and what the views of those who have interacted with them are. Our relationships are based on trust and partnership and the actual experiences of knowledgeable third parties are key.
Finally, while the information we are requiring is similar, we now have higher expectations on what needs to be formally documented and shared. So really it’s just enhancing each stage of the process to create an increased level of transparency to give us the appropriate level of comfort with the manager’s team, processes, and results.
HOW DO YOU BALANCE THE NEED FOR TRANSPARENCY AND CONFIDENTIALITY? ARE MANAGERS FEELING MORE VULNERABLE WHEN SHARING SENSITIVE INFORMATION WHEN YOU CANNOT BE IN THE SAME ROOM?
AH: We do have higher expectations around information and document sharing. And we are communicating in more detail upfront about expectations and the process for allowing our teams to access necessary information in a way that still provides the manager with a high degree of comfort and confidence. In newer relationships, it can take more time to build that trust and find the right balance. It’s a conversation and requires flexibility and partnership from both sides.
As an example, there are many documents that managers would typically bring to an in-person meeting, but not always release to us, such as an SEC examination letter, compliance manual, and other sensitive documents. Now, instead of bringing it “into the room,” they might bring it up on screen in a video call and allow us to know that it exists. We, of course, agree not to screen capture it. The usage of NDAs and data rooms is becoming more common.
Reviewing order management systems is particularly challenging, but we are seeking creative solutions and may also reach out to service providers as another source on what systems or services are in place. It’s “trust but verify.”
In general, managers have been amenable to these shifts and pivots. Many of them are implementing similar measures with their portfolio companies and potential investments, so this is not new to them. They understand this is reasonable. Trust is a huge part of these relationships and if these changes are necessary in a virtual world, then they get it.
ONCE YOU’VE GATHERED THE APPROPRIATE INFORMATION ON A MANAGER OR FUND, HOW DO YOU ULTIMATELY RATE THAT MANAGER? HAVE YOUR INTERNAL PROCESSES SHIFTED AT ALL IN THIS NEW ENVIRONMENT?
AH: We have very clear processes that must be adhered to during due diligence, with built-in checks and balances, and we employ a discipline that cannot waver. We will not lower the bar on our process or on what constitutes a high-quality investment opportunity.
Any shifts internally largely mirror the shifts externally. Just as we have enhanced our requirements with managers on communication and transparency, we have enhanced those requirements on teams performing the due diligence to ensure our Investment Committees can have the highest level of confidence in the work that’s been done and how the team developed conviction. Our Committees are ultimately responsible for approving an idea as suitable for broad client investment, so they need to understand all the ways we have interacted with the manager, service providers, and other sources we have leveraged in our diligence.
It’s about deeply understanding how the research team got comfortable on all the various criteria that we are assessing.
WE’VE FOCUSED ON MANAGERS THAT ARE ON YOUR RADAR AND HOW YOU GET THEM THROUGH THE DUE DILIGENCE PROCESS. BUT HOW ARE YOU ACTUALLY SOURCING NEW IDEAS IN THIS VIRTUAL WORLD? IS IT HARDER TO UNCOVER THEM FROM “AFAR,” SO TO SPEAK?
AH: Idea generation has always come from multiple sources. Our investment teams are, of course, a massive source of ideas, and our clients are also a meaningful source. Even managers can be helpful in identifying competitors and other firms they respect in their spaces. And of course, portfolio managers that we know from established firms start their own firms or move to other firms, which may lead us to take a first or fresh look.
We still have a very broad reach and a broad network, which are core components of our robust pipeline of new opportunities. We continue to have a full calendar of meetings with new firms that we are meeting virtually. Through August, we have conducted 3,500 formal manager meetings this year, and there are hundreds of less formal manager touch-points not captured in that figure. During the same time-frame last year, we had conducted about 3,900 meetings. So while a slight dip is to be expected in this anomalous time, we have certainly kept pace with a robust pipeline of opportunities in our purview.
IT’S A LOT MORE ART THAN SCIENCE, IT SEEMS.
AH: This is about much more than just adding steps to a process. We’ve always said, “This is more than a checklist,” because just adding to a checklist doesn’t necessarily translate to sourcing opportunities or developing conviction on best ideas. And it’s not just about knowing what “ingredients” go into establishing the conviction. We must understand how those different “ingredients” work together to make this a best idea.
We might be using slightly different or enhanced means to get to conviction, but we absolutely won’t lower the quality of the criteria needed to come to that conclusion.