All the right moves

The fight between the institutional fund managers and their boutique counterparts in Australia over market share, at least in the equities space, appears to be headed for a draw.

Both sides are still capable of swinging viciously at each other, but ringside commentators are not fooled, not after the torrid early rounds of this decade, when boutiques very nearly threw in the towel.

They see that any blows traded these days are targeted at the metaphorical equivalent of the shoulders and upper arms and that both sides have fallen into a comforting professional clinch.

For the boutiques, a draw represents nothing less than a resounding victory, in that their survival is now guaranteed, and for the institutions too the outcome makes financial sense.

Notably over the past 12 to 18 months, the boutiques have embraced the notion that the financial and distribution clout of the institutions hold the key to their continued growth and commercial success.

More than ever before, boutiques, both established businesses and start-ups, are seeking to partner with institutions for seed capital and also to extend their distributional reach, as well as for back-office, marketing and compliance services.

Also, key boutique investment managers often now receive ownership equity from the institutions, as well as the guarantee of independence to make investment decisions.

For their part, the institutions cling to the realisation that boutiques are the crowd favourite both among investors and planners, and consequently partnering with them is a better commercial strategy than trying to eliminate them.

There is now “a plethora of options for institutional partnerships open to investment managers, making it easier than ever to start a boutique”, according to van Eyk head of research Jerome Lander.

“It really comes down to their skill level and how well regarded these are in the market, whether or not they will have success in partnering with a larger group.”

Lander said the partnership model varies in the complexity of its structure across the marketplace, but there is “no doubt the institutions can make it a very attractive option for investment personnel”.

“These days, institutions will commonly share in the equity of the boutique — albeit sometimes only a minority share — and they will often provide start-up costs, or a substantial part of the start-up costs, and also distribution.

“They even provide quite a lot with respect to supporting systems, even down to supporting the investment process directly, and back-office administration.”

In turn, Lander said, while it costs a “fair bit” for institutions to partner a boutique start-up, in the context of the potential payoff it’s not a lot.

“If you assemble the right investment personnel, and they perform, and you have a distribution platform, and you can get ratings and get money in the door, then you can do very, very well out of it.”

He said that in this equity partnership model “usually the boutique is totally independent in terms of the way they invest, with no interference by a CIO, or anyone else from the institution”.

“There is often, in fact, a reciprocal expectation by the institution that the boutique remain true to an investment style, which can then be clearly communicated to the market.”

Perennial Investment Partners head of retail funds Brian Thomas said the “idea of putting together corporate ownership around boutique funds management has become very popular” in Australia.

Perennial as a collective of six boutiques (so far) is just one example of this, alongside listed groups such as Treasury Group and Equity Trustees, and some other newer players looking at that model.

Thomas champions the Perennial model for having the backing of a large organisation (IOOF) and also that participating boutiques have significant equity in the operation.

“We are also flexible with each boutique business we want to bring on board in terms of the parameters we place around it, including the size of the team that we start with, the size of the opportunity, and how long they will need to build a track record.”

How independent a boutique can potentially be under this general partnership model depends on how much equity the investment managers own, Thomas said.

“If you look at Perennial Value Management in our set-up, for example, the participating portfolio managers own 50 per cent of the firm, and they have a large say in its future direction.”

The only way to be totally independent as a boutique is to be 100 per cent totally owned, he said, but “then again there are other issues involved with wholly-owned boutiques”.

“How do they attract other investment staff, for example, and how do they build a long term sustainable business, rather than just a business that relies on one person?

“If one person wants to retire under the wholly-owned model, the whole business goes to zero,” he said, “whereas the institutional model can solve a lot of those issues and build a sustainable business over time”.

Perennial talks to potential boutique fund managers “every other day of the week” that are interested in looking at the Perennial model with a view to launching a start up, according to Thomas.

“These people are invariably lesser known, although not necessarily lesser quality, investment managers wanting to start up boutiques with a longer term expectation in terms of funds flow.”

The sheer volume of money available to be managed in Australia is “driving investment talent into boutiques, and not only from the funds management side,” he said.

“It’s also coming from the sell side (the stockbroking side) and from some quantitative focused people who are looking at this boutique thing in a different way.”

Many of Perennial’s visitors are interested in partnering with larger groups “particularly to provide their back office, responsible entity requirements, and all things they need to be active in the market”.

“Setting up a boutique can’t be done on a shoe string any more, not least because of the burden of legislative requirements being imposed on the industry.”

Another reason, Thomas added, was the current strength of the retail master trust market, where the “money is a bit stickier and margins are slightly higher”.

To do this, however, they need a “little bit more infrastructure in terms of having a PDS structure, and having a partner that can, for example, ensure their daily unit pricing is done correctly”.

Ian Macoun, chairman and managing director of Pinnacle Investment Management, is also an adherent of the partnership model that “combines independence for a boutique with backing from an institution”.

The Sydney-based boutique funds management group was established late last year with backing from Wilson HTM Investment Group on the basis of a similar model.

It has aspirations of becoming a multi-boutique funds management group, but initially comprises of two boutiques, Hyperion Asset Management, which it claims manages $1.3 billion, and Plato Investment Management, a new quantitative funds boutique.

A former Perennial chief executive, Macoun said that over the past 12 to 18 months in particular institutions have “moved from viewing boutiques as the enemy to an acceptance that the market actually wants boutiques”.

“They’ve realised that they are going to have to find a way to work with boutiques, and there are a variety of ways that they have found to do so.

“Sometimes they’re taking equity in the boutiques, while some are start-up distribution arrangements, and yet others have started as distribution arrangements and have developed into equity arrangements.”

A related development over the past 18 months, he said, is that the institutions themselves have “moved to try to make their operations more like boutiques”.

“The question is whether they have the desire and ability to give their investment people the sort of autonomy required to facilitate boutique-like characteristics.

“To enable the boutique to continue to produce alpha often requires capping the fund at a certain size, for example, and this is often something that is very difficult for institutional executives to agree on.

“It’s much harder for institutions to do that, than it is for a boutique, as they tend to have top-down financial budgeting where they want to try to get ‘extra’ flows.”

Some institutions have made the “paradigm shift” to overcome those inclinations to control the investment process, Macoun said, but many are “pretending at it, but they don’t really”.

“It’s inherent in the nature of institutions that there is always an executive who thinks he knows how to do it (investing) better, and also they panic when a style is out of fashion or favour.”

However, he said that unless an institution can make this paradigm shift in attitude they will “never be good at investment management on a sustained basis”.

“There are many institutions that are still doing investment management — although some have given it up entirely to focus on distribution — but I believe on the whole they are doing it poorly.

“It varies, of course, but generally they have very large FUM and, since too much FUM inhibits performance, that means they have to operate in a way that produces less alpha, if any for investors.”

Jody Fitzgerald, head of retail investment services at Skandia, does not see any significant signs that institutions are “choosing to dump asset management altogether to focus on distribution”.

“What we are seeing, though, is a number of distribution alliances being started up as a result of the institutions wanting to tap the strong growth they are seeing within the boutiques.

“These alliances are effectively making it easier to start up boutiques because distribution capability is something they don’t necessarily have, nor want to build.”

Skandia has been a leader in the field of partnering with boutiques, Fitzgerald said, having been the founding client in a number of start-ups, including, for example, MIR.

“We don’t require boutiques to have a three-year track record before we will look at partnering with them, which is what some institutional investors out there require.

“Instead, we spend a lot of time assessing whether a boutique will be capable of meeting its performance targets, and also whether or not the founders are high quality investment people.”

She said Skandia’s partnership model is “simply to invest money in a boutique’s funds, which we then offer to our clients — and in so doing ensure we are not in the same space as the boutiques and don’t actually compete with them”.

Lonsec investment analyst Silvo Glavan agreed with Macoun’s contention that there is an ongoing trend by institutions to mimic the operations of boutiques, which he believes is also a response to the loss of key staff to boutique creation.

“We are seeing that the institutional managers are increasingly using the boutique model in their own structures to try to give their investment teams greater incentive to stick around.

“This involves doing a lot more by way of upgrading their compensation structures, including profit sharing schemes such as equity and shadow equity.”

Glavan said there has, in fact, been a “lower staff turnover” among the institutions over the past 12 months compared to a few years ago, which “could be the result of the compensation measures or merely a function of the market cycle”.

There have also been lesser known investment managers leaving the institutions to start up boutiques, compared to a few years ago, he said.

“They are still very impressive as investment managers, but if you compare them to the likes of Peter Morgan and John Murray, formerly of Perpetual, they’re not of the same calibre.”