The power in staying small

When setting up businesses, many asset managers may focus on growing their funds under management as quickly as possible. But there are some boutique firms which are opting to eschew this route in favour of retaining control of their business and acting quickly for their clients.

Boutiques can offer many advantages for investors compared to their larger competitors. They often have less funds under management and a more flexible investment process. This allows them to move quickly and invest earlier than larger fund managers.

Bigger funds, with their committees, boards, management and compliance teams, may be restricted from deviating from the more rigid investment process frameworks that larger funds operate in. They also have a larger minimum investment size which can restrict their investable universe to the bigger, slower-growing businesses as opposed to the smaller, faster growing companies. 

That’s why lean boutiques like MX Capital, Lumenary Investment Management, Fairlight Asset Management and Endeavor Asset Management (half of which have only one person running the show), can attract investors looking for unique strategies.

GOING IT ALONE 

Weimin Xie, portfolio manager and founder of MX Capital, a wholesale high conviction, fundamental-based investment fund, started his ‘one-man band’ boutique a few years ago.

“I decided that I wanted to start my own fund because of a key difference that a small boutique offers,” he said.

“If I control the product, the size and I control my client base, then I should be able to better negate the adverse impacts from institutional imperatives.”

With about a decade of experience working on bigger funds, including the $600 million Ophir High Conviction fund, Xie believes a conflict of interest exists in bigger funds that is not present in smaller ones.

He said some owners of bigger funds are incentivised to increase their funds under management so they can maximise the return on their management fee – which ends up taking away a key advantage that small funds offer.

That’s because, as Xie puts it, “too much money shrinks your investment universe” which is explained below.

ACTING QUICKLY

Using the example of recent nervousness around China’s crackdown on the technology sector and the national education system, Lawrence Lam, founder and managing director of Lumenary Investment Management, said his investors benefited from his fund’s ability to actively seize opportunities as they appeared.

“A large fund may be very constrained in how they approach opportunities. They move like ocean liners, so decision making is slow. It may take weeks from inception of the investment strategy, moving the capital, through to trade execution. By that time, the window of opportunity can change as we saw during the pandemic last year,” Lam said.

“Whereas, if I just use my fund as an example, a boutique has that flexibility to capture opportunities in real time, unencumbered by red tape.”

Lam entered directly into the Shenzhen China A-shares market when institutional investors were pulling their capital out, as stock prices fell over 60% from fears of Chinese education sector reform.

Lumenary, which has $90 million in funds under management, aims to outperform the global market over the long-term (which the fund defined as more than one market cycle), by investing in founder-led companies through long-only, unhedged global equities.

Since its inception in July 2017, Lumenary has cumulatively returned 81.13% net of ongoing fees up to 31 August this year.

Part of the reason for that success, Lam said, was boutiques like his could avoid the kinds of “group thinking” that goes on at the institutional level.

“What happens is that when one [big fund] pulls their money out and the analyst recommends that it’s not a good time to be in a certain stock… [then this] leads to the 50% to 60% falls in price that we saw [after China’s overhaul of the education sector],” he said.

“I don’t have to take the advice from stock analysts, whereas institutional guys can’t stick their necks out too far, they want to stay within peer recommendations.

“I sit outside of that, I make up my own mind, my investors back me for the decisions I make, not the people I listen to. I’m also directly accountable for the decisions I make. That clear responsibility makes me closely aligned with my investors.”

Lam said he looked past falling stock prices in China and what the institutions were doing and, instead, capitalised on an opportunity he saw in a quality Chinese education company, buying stock at 60% discount to its valuation.

Similarly, Hayden Beamish, chief executive and portfolio manager of Endeavor Asset Management, said his high conviction fund, which targets small companies early, had been able to benefit from its nimbleness by finding high-quality companies before they were researched and well understood by the wider market.

Endeavor has $400 million spread across three core strategies. One of which is its High Conviction fund, which has $100 million invested in 20 to 30 holdings, allowing the fund to invest in small companies earlier than competitors.

In other words, a smaller fund like Endeavor invests less per investment than a bigger fund which means it can buy or sell stock from small-cap firms earlier and without the same liquidity risks.

“That’s where you can really generate outperformance, especially relative to the Australian market which is concentrated at the top with the banks, resources and a telco,” Beamish said.

For example, Endeavor was able to buy 5% of IMDEX, a mining services company, when it was only valued at $65 million and trading at 16 cents per share. The company is now worth close to $1 billion.

Beamish said his fund was able to trim their IMDEX stock at 60 cents when the equity reached the level of liquidity that allowed bigger funds to invest for the first time.

“Our biggest successes have come from these smaller businesses on the [Australian Securities Exchange] ASX that end up in the top 200,” he said. “They’re not growing at the mercy of the economic cycle; they’re growing on their own merits.”

With this in mind, Beamish said he would look to soft close the high conviction fund when it reached $200 million and hard close at $300 million in order to retain the ability to source the type of small-cap opportunities that had contributed to its returns.

Nick Cregan, portfolio manager and co-founder at Fairlight Asset Management, a global long-only small and mid-cap fund, agreed that part of his boutique’s success is driven by acting fast.

“We break our process down with an emphasis on speed to begin, ramping towards greater diligence and detail as the analysis moves through a series of steps. The idea is to ensure our time is spent on the most prospective ideas and to keep morale high by not wasting time,” he said. 

“Too often in large institutions analysts are asked to perform analysis on ideas that have no chance of portfolio inclusion. This wastes time and leads to employee turnover. Instead, our team works rapidly on ideas that interest them where we believe we have an edge.”

WHERE TO FOR BOUTIQUES?

Cregan pointed to a 2018 analysis of boutiques published by Affiliated Managers Group, which demonstrated that boutiques significantly outperformed non-boutiques in institutional equity categories. The greatest outperformance, it said, was found in small-cap and emerging market equities.

Several factors were credited for this outperformance including improved alignment of interest, investment-centric organisational cultures and a team commitment to building an enduring franchise.

But investing in boutiques is costly and, according to Beamish, the situation is getting worse because of rising compliance and operating costs.

“So now it’s harder to service retail investors because of compliance costs so funds are having to get bigger and bigger to cover their operating costs, so there’s fewer smaller funds [starting up],” he said.

“Investing in the market has become more efficient, you’ve got access to all global products, brokerage is cheaper but your actual services like your accounting, your insurance, your custody – the actual operating model of a fund is becoming more expensive.”

So, boutiques that wish to stay small and independent must come up with clever and efficient business management solutions to deal with challenges and costs – often through technology and automation of manual tasks.

According to Lam, there was a big trend for boutiques to outsource tasks like fund administration to minimise costs and focus on the investment side of things.

Instead, Lam chose to keep as much in-house as possible because he believed that allowed for accountability to investors and most importantly, it allowed a fund to keep its independence.

He did this by developing his own client portal technology that saves headcount and, according to Lam, is a different approach to larger funds who tend to throw more people at operational challenges rather than leveraging technology.

“When you have that independence, when you stand on your own two feet – that’s when you can truly be independent and make good decisions and not have to be unduly influenced,” he said.

Lam had been approached by several fund managers interested in his client portal technology who were looking to drive down their business costs and improve efficiencies, which Lam said would ultimately benefit retail investors.

As for what is holding boutiques back, Beamish says it is the status quo that wealth managers and financial planners adhere to which leads to them opting for larger firms which may perform worse than a boutique.

“I think the best returns are from boutique fund managers, but the industry is set up in a way that the people allocating clients’ money to fund managers, don’t want to look stupid so a lot of the flows go to the big brand institutional managers," said Beamish.

“I guess that’s the constant battle of the boutique manager.”