Boutique fund managers bring a more focused approach to investment management, but they also face many challenges, writes Nicholas O’Donoghue.
Despite the majority of boutique managers having histories of working for large institutional fund managers, they generally take a more aggressive approach to investment when they go it alone.
By nature they are passionate about the area they choose to focus their funds on, but sometimes passion is not enough and in a post-global financial crisis (GFC) era, starting up a boutique has never been tougher, according to those monitoring the sector closely.
Breaking down the universe
Given the broad spectrum of fund managing options and the people involved, Morningstar research manager, Tom Whitelaw, said it was impossible to make broad-stroke assessments on boutiques versus institutional mangers.
However, he said that an analysis of 47 institutional funds and 41 boutiques provided some traits that separate them.
“We broke down the universe and split it between institutional and boutique managers, and created an average of what we would term a boutique and what we would term institutional,” he said.
“And what you see is what you would expect - insto managers tend to be slightly lower risk, so they tend to be closer to the benchmark, they have lower tracking errors, they might have a bit more large cap investments, and they’ll have lower standard deviations.
“So less volatility and that’s really because they have established books of clients and goal number one [for them] is not to lose clients, so they want to keep the funds that they’ve got and grow it where they can.
“Whereas the boutique managers tend to take more of a swing because they are looking to establish themselves and create a name, so you’ll see they’ll be taking higher risks, they might have higher propositions, they probably have greater tracking errors, and they may go a little lower down the cap ladder.
“But what that means is in up-swing markets like we’ve had over the last five years since the GFC, you would expect the boutiques to outperform the instos, because they’re taking on a bit more risk, their portfolios are a bit more punchy, but the insto managers you would expect to better protect capital in a down turn.”
Whitelaw said that Morningstar research supported the view that boutiques performed well in up-swings, with data showing strong performances in the post-GFC era.
“If you look over the short-term, the five, three and one year figures, the boutiques would’ve out-performed [instos] given it’s been a bit more risk-off,” he said.
However Morningstar’s figures revealed that over the last decade insto funds have out-performed boutiques across both large and small cap sectors.
Although the average boutique fund has fared slightly less well compared with the average insto fund over the course of the last 10 years, there is still a lot to like about them, according to K2 Asset Management head of distribution, Andrew Hall.
“There’s a really strong alignment of interests between the fund managers, the business and what clients are trying to achieve,” he said.
“Therefore, what benefits the fund manager is what benefits the client and I think that’s a really important aspect of a boutique operation.
“Boutiques are generally much more specialised and that’s what appeals. You’re getting someone who is a specialist.”
Boutique fund support provider, Fidante Partners general manager, Cathy Hales, also believes the in-depth knowledge of an asset class a boutique manager has is key for its success.
“What a boutique brings to the table is a lot of focus,” she said.
“With a boutique you gain a team that’s very focused on delivering a strong client outcome, and that’s not to say other managers many not be, but in the boutique environment there is an alignment of interest between investors and the principles who have a lot of skin in the game through their equity ownership of the business and entitlements.”
Hales said the recent performance of boutiques had also played a role in attracting clients.
“I think the environment will remain positive for quality boutiques to perform really well for investors, and to attract their support,” she said.
“Like anything, the investment environment sort of guides where investors will put money flows and it’s up to boutiques to differentiate their investment strategies to make sure they are well positioned to attract that flow, because they can deliver a really good investment outcome for clients.
“But the challenge is prevalent for any fund manager. A boutique just has to be focused on making sure it’s clear how it will add value and where it will add value for an investor to be able to choose them.”
Continuity of service
Premium China Funds Management head of distribution, Jonathon Wu, said one of the strengths that boutiques have over insto managers is the continuity they offer.
“One thing that boutique managers always have is that there’s a personal touch to it,” he said.
“Generally they have less staff turnover and more continuity of staff.”
Frequently, boutique managers have cut their teeth with larger institutional funds, before branching out on their own, and the reputation they bring with them can be critical to their success, Morningstar’s Whitelaw said.
“It’s very difficult to come into the market from scratch,” he said.
“You really do need that reputation [for success as a manager of an institutional fund] if you’re going to be running a boutique fund... It’s almost impossible without it to be honest”
However, he said that research houses would question the motivation of a manager with a reputation in large cap investments setting up a small cap or alternative boutique.
Being an independent business, boutiques require a multitude of skills beyond those most fund managers gain while working in an insto setting, Whitelaw said.
“All of a sudden they’re in their own boutique and they’ve got to worry about their receptionist being off sick and what systems they’ve got in place, how the back and middle office functions,” he said.
“They’re handling a P and L for the first time¨ it’s why you see a lot tying up with a boutique incubator, who’d often own half of the business and who would provide that support.”
Hales agreed that reputations as good money managers counted for only part of the recipe for success as a boutique.
“Looking for the right support to manage the business side of the equation, while remaining focused on executing their investment strategy is key,” she said.
While K2’s Hall accepted that running a business required boutique fund managers to look beyond their core money management role, he said they need not be overwhelmed by the task.
“A lot of the administration side and registry aspects can be outsourced¨ so your primary function is just the funds management business,” he said.
“[But] it needs to be someone who had got the skills to run it as a business.”
Although weaknesses in areas such as administration can be overcome by outsourcing roles, starting from scratch is a challenge nonetheless, Hall said.
“To start from scratch, you’ve got to get on the platforms, you’ve got to get on the approved lists, it’s not easy,” he said.
“There’s a lot of gatekeepers, the research houses want to see experience, they want to see track records.
“So to get into the retail space is pretty difficult and does take time, unless you can find money from a few key high net worth individuals or if you’ve got the backing of a small institution or such like.”
From a research house perspective, Morningstar’s Whitelaw said they need to be convinced of the longevity of a boutique before recommending it to clients.
“We want to make sure it’s a viable concern,” he said.
“In the boutique space we want to make sure that the manager had funds under management that can support the wages of the staff and what have you. [We want to] make sure it’s a going concern, because the last thing we want to do is be recommending a strategy that’s subscale and has essentially no plans or arrangements in place to be able to be a going concern.
“What that figure would be and what would be a breakeven point varies depending on the boutique itself, its cost centres and also its client mix. If they’ve got a lot of retail clients paying higher fees then that breakeven point is going to be lower, but if say they’ve got a couple of very large institutional mandates it’s also something we would bear in mind, because institutional money tends to be less sticky then retail money.
“If you lose one of those big instos it can basically take you from profitable to unprofitable overnight.”
Whitelaw added that staffing levels of boutiques were also something that researchers considered before recommending them.
“If it’s just a one-man-band, has he really got enough scope to cover the investment side, the research side, the trading side, even the marketing?”
With the need for capital imperative for boutique fund managers, Wu believes that those starting up now may need to look for institutional managers to partner with, so they can gain access to better infrastructure.
He said that getting access to a “distribution footprint” through an institution - either by selling the overall or partial ownership of the boutique to one of the big mainstream players - was a tried and trusted way for boutique managers to ensure their future viability.
“At the end of the day your performance might be absolutely stunning, but if you were being dropped by institutions or [not] accessing financial advisers, you’re not going to go anywhere,” he said.
“The institutions are still launching a proliferation of funds at the moment and they have the balance sheet backing - that’s why a lot of boutiques are going and talking to the institutions and saying 'take an equity stake in my business¨ I want to leverage off your distribution footprint’, because that’s what they’re offering.
“The institutions are looking for the ones that are short of capital and want help just to get their foot off the ground and get that first $50, $100 or $200 million to break even¨ [because] if you’re a boutique the first $50 million is the hardest $50 million you’ll ever work for.”
While the post-GFC environment has seen boutiques perform well, Premium China Funds Management’s Wu believes it is now more difficult to get the traction to succeed.
Wu stressed that scale and having “capital to burn” was imperative for those looking to establish a boutique in the current climate.
“One of the biggest challenges boutiques face is scale. You might have a great idea, a great way of doing things, a great track record, but if you don’t have scale you’ll struggle.
“A fund manager is like any other business, you have to be very cognisant of what your burn rate is going to be. How many months or years you’re willing to go without a dollar coming through the door? How much money do you have to burn?
“Post the GFC it’s three or four times harder to launch a boutique than it was prior to the GFC.
“I could definitely say that if we launched the China Fund post-GFC I don’t think we could survive without scale.
“I’ve had quite a number of friends who are trying to launch asset management businesses post-GFC and it’s been really tough going just trying to convince people on the investment opportunities.
Despite the challenges facing those wanting to launch their own boutique proposition, K2’s Hall believes it is possible to capture a viable niche market.
“Because the whole pool’s growing there are always opportunities for people to eke out a small part of that [investment capital] pool,” he said.
“Are boutiques taking a bigger percentage [of the market]? Maybe not, because the pool’s grown so quickly and the really big players control a lot of the distribution, they advise as well as manufacture, so they are positioned to get a very large proportion of it.
“But that doesn’t mean that boutiques can’t continue to make inroads and find opportunities.”
Hall believes that recent poor publicity in the financial advice sector may strengthen boutiques’ proposition as concerns over the independence of advice “filters down to the funds management side”.
“There’s always going to be people who are looking outside the major players¨ there’s always people looking for someone who is perceived to be independent whether it’s on the advice side or the product manufacturers’ side,” he said.
“There are people who really think about their investments and are out there trying to find [the right fund for them] and doing their homework, [and] independence will be a really important differentiating point.”
Although he predicted that the majority of investors would continue to invest their super contributions with the big players, he said independence would be important for the growing number of self-managed superannuation fund (SMSF) investors.
“A lot of those people are out their looking for people who are independent to provide some of those services,” he said.
“So that plays into the hands of the boutiques as well, because there’s more and more players