Adopting the boutique formula

While 2004 was the year of the boutique, 2005 was, well, the year of the boutique.

Despite less boutique start-ups in 2005, small, non-institutionally aligned fund managers still dominated the headlines with their outperformance.

Michael Triguboff’s MIR took out the Australian equities sub-class of Money Management’s Fund Manager of the Year Award. Alliance Bernstein, considered a boutique in Australia for the small size of its operation, got the main prize as well as winning the international equities category.

Stellar performance

When research house Lonsec reviewed 39 Australian equities funds in November last year it awarded five out of six of its top category ‘highly recommended’ ratings to boutiques. Funds managed by Ausbil Dexia, Tyndall, Investors Mutual and Perennial were the stand outs.

Those associated with boutiques also did well. Fund incubators Equity Trustees and Treasury Group, which have distribution and responsible entity arrangements with the likes of MIR, Orion Asset Management and HG Hiscock, reported monster inflows.

Equity Trustees, for instance, reported several weeks ago that it had posted a whopping 190 per cent increase in net fund inflows for the half year to December 2005.

Large institutional managers, though, haven’t taken the success of the boutiques lying down.

But in what is probably the biggest proof of the boutiques’ success, rather than trying to intimidate with their colossal size as they have in the past, the likes of CFS and Challenger have taken the ‘if you can’t beat them, then you might as well join them (or buy them)’ approach.

Institutions fight back

Last year saw an unprecedented number of attempts by big, or big bank-aligned fund managers to mimic or buy into boutique operations.

At Perpetual, key researcher pay checks were fattened to exuberant levels, where possible, equity stakes have been offered, and distribution at several large organisations separated from manufacturing to enable personnel to stay focused on managing money.

Such moves could well have stemmed the number of boutique start ups in 2005, according to Skandia head of investments William Burkitt.

“The rise in boutique start-ups really fell away in 2005 when you were starting to see the results of the larger managers restructuring their contracts with their portfolio managers and analysts.

“But you’re also getting large investment hubs like Perennial.”

IOOF-backed Perennial has set up a number of what it defines as boutiques operating as separate companies that are 50 per cent owned by personnel and 50 per cent owned by Perennial.

“So the investment team can make money for themselves, and they’re willing to close their funds at a reasonable level before capacity constraints kick in,” Burkitt says.

The most recent of these start-ups, a listed property fund that is due to open for inflows in the coming months, has already received a massive endorsement.

In January this year, the head of CFS listed property team Stephen Hayes defected to the Perennial operation, and he took the rest of the CFS team of five with him.

While nobody is exactly sure why Hayes and the entire CFS team decided to defect — Perennial and Hayes are keeping mum until the operation is fully up and running — Morningstar head of research Justin Walsh can hazard a guess.

“You go to a boutique because you want to own your business,” he says.

“There is the attraction of control and the attraction of wealth. If you can build a successful boutique, you can make a lot of money. With Warwick Negus we don’t know what he got for his stake in 452, but we can be sure it was a lot.”

Taking an equity stake

Ironically, then, it is the large organisations like IOOF and the bank-backed managers that are contributing to the rise of boutiques.

Last year, there were several moves by big managers to do what Colonial First State did with 452 in 2004 and St George-owned fund manager Advance has been doing since 1994: forget about managing money and just focus on distribution by taking equity stakes in boutiques or fencing them off in exclusive distribution deals.

In its first attempt to offer international equities to Australian investors, the late Kerry Packer’s Challenger Financial Services decided to make this possible by buying a 25 per cent stake in boutique manager Five Oceans.

A similar deal has been struck with small caps manager Kinitec, started by the ex-head of HSBC’s small cap funds management operation in Australia purchased by Challenger in 2004.

Another large boutique-oriented organisation making inroads into the Australian market, global fund manager Mellon Investments, has taken that one step further by buying entire boutiques. But the boutiques still call the shots.

“We don’t tell any of our acquired organisations how to manage their money,” Mellon Australia managing director James Gruver says.

“We have 11 organisations and we have 11 chief investment officers. When we recently sent out a series of economic forecasts, not all of them were the same.”

Exclusive distribution

Advance managing director Kate Mulligan, whose organisation was the first to exclusively distribute a boutique to the Australian market back in 1994 with Maple Brown Abbott, says its exclusive arrangement to offer MIR to investors has already attracted $250 million in funds under management. Some of that has been allocated to the non-exclusive, multi-blend fund as well.

“The figure gives you an indication of interest in this area. Advisers are looking for something a bit different at the moment and are particularly looking for alpha,” Mulligan says.

Zurich investments specialist Peter Walsh said its recently formed partnerships with boutiques Constellation and Renaissance give it a competitive advantage over other institutions.

And then there’s Macquarie Investment Management, which signed up Concord Asset Management to its Professional Series with another Australian boutique to be signed up by year’s end.

Such arrangements initiated by the big end of town will continue to help boutiques flourish. They will benefit from the back-office, marketing, compliance and distribution support of their institutional partner, which, no doubt, will take a hefty cut of profits.

More accessible support

But there are still plenty of boutiques that are doing it on their own.

For those too young or unsuccessful to attract such institutional backing or for those boutique purists who think such arrangements are pushing the boundaries of what is and isn’t ‘independent’, there are a swag of new support companies appearing on the radar. These include BDM Direct and the Private Collection, which provide marketing support, and FundHost, which, much like Treasury Group, provides back-office support.

And such support is coming cheaper and cheaper.

This is why Burkitt believes that no matter what the institutions do, boutiques are here to stay, even if they don’t have any institutional backing and even when the market takes a dive.

“I’ve seen the Australian industry go through fits and starts with boutiques. But the difference with this trend over the last three or four years is the advancement of the technology and outsourcing services, which are much more accessible and cheaper,” he says.

And there are still things boutiques can offer the top talent that the institutions can’t.

“We’ve noticed institutions have been discovering economies of scale and discovered their teams are too big, so they’re trying to copy boutique-style practices. But they’re not easily being duplicated,” van Eyk head of research Gerome Lander says.

“In some cases they’re not doing enough for long-term incentives; some of them aren’t easily able to offer equity ownership.”

Mulligan adds: “Next time we get a downturn there will be a shakeout and we don’t think all boutiques will survive and that’s why we’re so vigorous before we take a boutique to market — but I don’t think we’ll see anything like the tech correction.

“But obviously some strong institutional backing wouldn’t hurt,” she adds.

Lander says consistent outperformance by many boutiques will ensure their survival through any potential market lows.

“A lot of boutiques have gone well below critical mass, so for a lot of them they will all survive, just because they’re really profitable organisations.”

A long-term position

So boutiques are here to stay. But is their influence a precursor to institutions dumping asset management altogether to focus on administration and distribution?

Moves by the institutional managers to buy stakes in boutiques, form exclusive distribution alliances, or replicate their business structures are not necessarily always an admittance on their part that boutiques are better than the institutions.

They are often based on their recognition that the boutique model is popular with a certain group of investors, or certain type of research analyst that they wish to tap.

Morningstar head of research Anthony Serhan pointed out in late 2004 that there was well over $40 billion in boutiques. But this still only accounted for 5 per cent of overall funds under management in Australia.

Although the boutiques performed well in 2005, institutions did too.

And although institutions like Colonial and Macquarie have bought equity stakes in boutiques, they are still running in-house funds that account for most of the money flowing through Australian investment managers.

“If you look at the returns you’ll notice the big guys have been doing reasonably well and I don’t think it’s a size issue,” ING Investment Management chief executive Grant Bailey says.

“Having the capacity to pick good stocks is what counts and to do that you have to be a good investor.

“Our investors are pretty much just investors. This view that they’re being burned by compliance committees — nothing’s further from the truth,” he adds.

Defying the critics

Capacity constraints, often touted by boutique managers as an institution’s biggest bugbear, are often overstated, according to Bailey.

Firstly, he says most of these critics, somewhat curiously, are often also advocates of strategic asset allocation.

Secondly, he says institutions can break up their fund into different styles to counter the problem — something that some of the larger boutiques have even been doing of late.

“Conceptually there is a limit to how much you can have in a fund, but where that line is depends on your style and how many other people are turning over stocks. Some houses, like Perpetual, which has $30 billion under management, seem to produce alpha quite well.”

And while there are investors who will never be happy with big managers, there are others who always will.

“Sleep-well factors and brand names will always be attractive to some investors,” Bailey says.

But this doesn’t mean ING is ignoring the boutique’s current success.

“Boutiques once had a go and didn’t succeed. But now they are a force to be reckoned with. But so are the big guys. The only thing I wouldn’t be is someone in the middle.”