Boutique fund managers - can rock stars grow old gracefully?

With large parts of the investment industry focused on benchmark-hugging rather than rocking the boat, it can be a tough time to be a boutique fund manager, but ultimately it all comes down to one thing, writes Freya Purnell. 

There is a well-worn path to success for a new boutique fund manager. 

Key members of the investment team at a major funds management house or investment bank decide to go it alone and set up shop – either with institutional backing, perhaps via a multi-boutique firm, or as a true independent. Institutions, attracted by the ‘rockstar’ factor, start throwing some mandates their way, and they’re off and running. 

Having built a track record of performance, the fund starts to see retail money flowing its way. 

Or does it? For many boutique fund managers in the current climate, this is where the storybook ending might fail to materialise. 

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It’s no secret that funds management has been a tough business over the last five years. Across the industry, institutions and boutiques alike are struggling to attract new funds under management, as investors shelter in cash and dabble in direct investments. 

The flight to safety has been strong in recent years, and this has disadvantaged boutiques doubly, according to Paul Moore, chief investment officer at PM Capital, with clients looking to eliminate risk and cut smaller players from their portfolio.  

“The reality is it should be a good environment, but the industry is becoming more and more fixated on hugging the index.

Typically boutiques tend to be more interested in genuine investment opportunities than just benchmark-hugging,” Moore says. 

In the retail world, advisers are still struggling for new business, and so there are only a handful of managers – boutique and insto – who are receiving healthy flows at the moment, says Jarrod Brown, chief executive officer, Bennelong Funds Management.  

“If you are a boutique winning money, you are most likely stealing it from somebody else, versus receiving new flows. I think that’s still the case right across the industry,” Brown says.  

Making the move to retail  

The consolidation in the super fund space, particularly among industry funds, is having a significant impact on boutique managers.  

As big super funds grow strongly, they have larger amounts to invest, and are allocating to fewer managers, according to Chris Douglas, co-head of fund research at Morningstar.

For a small boutique, a mandate of a couple of billion dollars might not only push them towards capacity, but it also increases the risks facing the manager. 

“Looking at the clients who make up these boutiques, it is interesting to see just how dominant some of the industry funds are to these firms. If they do make a large change, they can take their money away quite easily as well, and that’s a very real risk for a boutique firm,” Douglas says. 

It’s a shift that Tim Samway, managing director of Hyperion Asset Management, has been watching closely. Hyperion currently has $4 billion under management, and as a concentrated benchmark-insensitive manager, is now capacity constrained. 

“One by one our institutional clients are coming back to us and saying, ‘We are merging with super fund B, and we want access to $800 million worth of capacity’, and we simply can’t do that in one go,” he says. 

Over the next 10 years, Samway says the fund’s institutional money will be slowly converted to retail, and he believes many of their competitors will be seeking to do the same. 

“I can see the writing on the wall that not all, but a number of our clients will merge, and that capacity will be available for the retail market.” 

Brown sees it as a natural evolution for boutique businesses. 

“At different stages of the lifecycle, there are deals that you do early in the incubation phase that are typically institutional, and that you will be much more unlikely to do as you grow.

"You want to see the portfolio mix diversify, and you gradually increase your percentage of retail.

"So it has a direct relationship or correlation with your size – your size relative to your capacity and the relationship to price,” he says.  

Lonsec investment analyst Peter Green says Lonsec is seeing pressure on boutique managers with large institutional books. 

“The pressure comes from fees, but also mandate losses, especially in the core-type products where insto money is leaving in big leaks due to a consultant downgrade, someone changing a mandate for an index, or insourcing,” he says.  

Cathy Hales, general manager of Fidante Partners, the multi-boutique division of Challenger, says while interest from institutional investors in its partners has enabled them to grow fairly quickly, the retail market is key component of the growth plans for many boutiques.   

Performance the driving force 

Rockstar investment managers might win the institutions over, but when it comes to attracting retail money to boutiques, performance is the be-all and end-all. Fortunately the trend is definitely moving in the right direction. 

“Performance has been pretty strong across the board. You often see with boutiques, particularly earlier in their lifecycle, the capacity issues aren’t there, they’re getting reasonable flows, and the guys are pretty hungry. Those boutiques are doing reasonably well in terms of alpha,” Green says.  

Morningstar figures to 30 June 2013 show that in the Australian equities large cap space, the average one-year boutique return was 22.22 per cent, up from 7.61 per cent over three years and 3.41 per cent over five years.

In the Australian equities small cap space, boutiques returned 14.35 per cent on average over one year, up from 8.72 per cent over three years and 4.67 per cent over five years. 

While there may be a perception that boutiques are more nimble, have more concentrated portfolios and take more active positions – and as a result, deliver performance well above their institutional counterparts – broad performance data doesn’t bear this out. 

Institutions were the stronger performers in the large cap sector, delivering 23.40 per cent, compared with the 22.22 per cent provided by boutiques over one year, while in the small cap area, the situation was reversed, with boutiques generating average one-year returns of 14.35 per cent compared with 10.99 per cent by institutions. 

Douglas points out that within the boutique market, just as in the insto market, there are standout managers and below-average performers. 

In the large cap sector, Douglas says established players Investors Mutual and Hyperion and newer entrant Bennelong continue to deliver very strong performance, while in the global equity space, the performance of boutiques such as Magellan and Platinum has picked up significantly over the last six months. 

Strong long-term performance was certainly a factor in Hyperion taking out this year’s Money Management Fund Manager of the Year award, becoming the first boutique in recent memory to take out the top award. 

Having delivered the goods for over a decade, this track record has helped Hyperion in attracting new retail funds.

While Samway says the usual disclaimers about historical performance not being a predictor of future performance must apply, “the reality is that a fund manager that has shown they are able to perform in the past – and has the same approach to managing money and the same business processes – has a higher probability of being able to replicate it in the future”. 

The focus on past performance can be a major frustration for all fund managers, but particularly for boutiques.

Moore says PM Capital endeavoured to encourage investors back into the market 18 months ago, as the fundamentals pointed to great opportunity in offshore investments. 

“It was like getting blood from a stone. The reality is that people like to look back and see positive numbers before they invest, which is crazy, because you want to actually do it when you see negative numbers,” he says. 

Over time, as their funds began generating positive 12-month returns, investors began to become interested, and their Absolute Performance Fund returning 77 per cent over the last year has certainly grabbed their attention. 

“Then all of a sudden, they are more open to boutiques, they’re more open to listening to the investment opportunity rather than worrying about their fear of what’s going on in the industry,” Moore says.

“My gut feel is that all of a sudden, the gatekeepers are a little bit more open to considering [boutiques], rather than just sticking with what they think is safe for their clients.” 

Appeal to financial advisers 

Traditionally boutiques have needed the ‘rockstar’ appeal to get off the ground, particularly to attract vital institutional funds.

Earlier this year, former Perpetual head of equities John Sevior certainly provided the shining example of this principle in practice, with his new venture Airlie Funds Management immediately attracting $3 billion from investors.  

“If you didn’t have much of a name or a track record, I think it would be almost impossible to set up a boutique, unless it was a niche type product,” Green says.  

But to win in the retail market, boutiques need more than this – they must also be able to clearly articulate their investment proposition and what they can offer investors, in a way that is both simple and compelling for advisers to communicate to their clients. 

When it comes to gaining traction in the retail market, many boutiques also report greater success – at least initially – with independent advice firms.  

“The more independent they are, the more they are likely to stay with a boutique,” Moore says.  

Hyperion also gained early retail support by approaching financial advisory businesses, often with three or four planners, who were looking for something different for their clients. 

Hales says an increased focus on portfolio management in the industry has driven the need for better communication with advisers. 

“For boutiques, what that means is being really clear about the role their strategy plays in that portfolio, and making sure they have got the support of the gatekeepers – the research houses, the dealer groups and the platforms – so that it’s simple and the adviser can really captivate their client in the investment strategy they are recommending,” Hales says. 

Having this clear investment ‘story’ can also be a crucial factor in encouraging advisers and investors to stick with a boutique manager through a challenging investment cycle. 

“The biggest mistake [advisers] often make is whatever the biggest performer is this year, they fall totally in love with, and then they switch and keep chasing the best performer.

"The reality is with the best investment managers, you need to stick with them through their full investment cycle, because you’ve got to let their ideas play out,” Moore says. 

As ‘maturing’ boutiques come of age, having a coherent identity as a manager will be particularly important as they make the transition from primarily institutional money to retail funds.

Being able to tell their story to retail investors may be more important to advisers than whether or not the manager has any institutional backing.  

Paul Kearney, CEO of Kearney Group, says the company’s financial planning practice uses well-managed boutiques to provide different views on the market that macro fund managers can’t provide. 

“When we want exposure to the smaller end of the market, we think boutique managers have a lot of conviction about what they’re doing, there are points of difference, it’s not crowded, and so they are able to add value,” Kearney says.  

“Whether it’s been pulled together under a major house isn’t really of any influence to us, it’s how well they can explain their position and whether or not what they are doing fits with what our clients need and are looking for.”  

For Hyperion, this understanding needs to go both ways.  

“We are very careful about which clients we choose, because we want an alignment of philosophy between us and those clients. That avoids unnecessary switching because the financial planner didn’t quite get what we are trying to achieve,” Samway says. 

Being close to the investment managers themselves is “an added bonus” of using boutiques, according to Kearney.  

“You are really talking to the people who are making the calls, and you find out what their position truly is and form an assessment of that, rather than getting it second- and third- and fourth-hand, which by its nature is what occurs with the macro funds,” Kearney says.

“That’s a big plus, because you get very close to what you think is the truth of what’s going to occur.” 

Another attraction boutiques offer, according to Kearney, is the ‘heavy skin in the game’ element – that the portfolio managers are personally invested in the success of the business. 

This has been such an effective part of the boutique model that even institutions are trying to replicate it in-house. 

“One of the great benefits of a boutique is that there is that alignment where people have equity,” says Green.

“We’ve had a couple of investment bank-type managers that have had a lot of issues with turnover, and what they have done to keep staff is to introduce quasi-boutique models, so there’s not equity ownership but there is revenue sharing. That’s actually been reasonably successful in terms of staff retention.” 

For newer boutiques, employee share ownership can virtually guarantee that key people will stay put. But with some boutiques notching up a decade or more in business, that key person risk may return.  

“People at different stages of their life want to do different things. So now the questions are, what is the transition for this business, how do they move to keep the business stable if a key person departs. It’s purely a case of the maturity we’re seeing in a lot of these businesses,” Lonsec general manager – managed funds research, David Erdonmez says. 

Attracting SMSFs 

As boutique players cast around for new funds under management, an obvious target could be the fast-growing self-managed superannuation fund (SMSF) sector. 

Douglas says SMSFs, as primarily independent and direct investors, may have a natural affinity with a boutique compared with a large institution, because of the alignment between the portfolio manager as a shareholder in the business, and the end investor. But the issue is how managers can reach SMSFs, from a distribution and marketing perspective.  

“All of the service providers are trying to work out how to participate in that space. Increasingly there has been a move to self-managed super funds as vehicles, but they are not necessarily fully self-directed,” says Brown. 

Hales believes that it is a difficult group of investors to captivate, particularly when they have been quite specific about what they hold in their portfolio, such as direct shares and fixed interest or cash investments. Where Fidante has seen interest is in products that might complement existing holdings.  

“For example, our global credit mangers and fixed income managers have been quite interesting to the self-managed super segment, as are some of our small cap managers that have a very distinct view of their investment approach,” Hales says.   

Room for more? Or consolidation? 

As the scramble for funds continues, with most managers still seeking FUM, the question is how sustainable is the boutique sector? 

Erdonmez says there are few new boutique players trying to start up in the Australian market, though there have been a small number of new funds coming to market. 

“It seems maybe it is getting harder to set up a boutique from scratch, and that makes sense given where the market is now,” says Green.  

Facing tough operating conditions, some independent boutiques may seek the relative security of an institutionally-backed multi-boutique firm.

Having brought global equities manager River and Mercantile Asset Management and residential and real estate investment specialist WyeTree Asset Management into the fold most recently, Fidante is still on the lookout for more partners.  

“We’re particularly keen to look at managers who have differentiated skills in international asset classes,” says Hales, adding that alternatives are also an area of interest, as investors with a concentration in Australian equity seek to diversify into complementary asset classes. 

With Pinnacle Investment Management, majority-owned by Wilson HTM, failing to sell when placed on the market last year, Brown says he can’t foresee the emergence of another multi-boutique in the near term.  

“I think the cost to build such a model is constraining,” he says. “We are still going to see consolidation of managers rather than the emergence of new ones in the year ahead, but that’s right across the board.” 

Douglas agrees that there may be some consolidation, but believes this will only be around the margins, as boutiques have a much more flexible cost base than large institutions, and so are perhaps able to weather market headwinds better. 

While over the last year there has been as much pressure on institutionally-backed boutiques as on independents, according to Erdonmez, the backstop of financial support also carries the advantage of offering perceived security to advisers and investors regarding the long-term sustainability of a boutique business. 

“Advisers and investors are captivated by many of the investment strategies that boutique managers provide to the market, but they want to know that they are going to be stable and from a business management perspective that they have got good quality corporate governance and financial stability,” Hales says.  

Green says Lonsec would lean towards those with institutional support, as it provides an easier path than going it alone as an independent boutique.  

“It is a very difficult thing to get some FUM in there, and you do have a have a period where you are losing money and you are at risk of losing staff,” he says.

“But then for boutiques with backing, there are other pressures from a corporate point of view, and you have to ask if it’s a truly independent vehicle, and are we getting the best ideas out of this team, or is there some sort of corporate overlay.” 

Brown argues that while a level of financial strength is critical for boutique managers, the actual ownership structure is less important than the firm’s demonstrated capability and capacity. 

“To rely on us as a house to produce great investment outcomes, [advisers] are looking to see that it’s appropriately resourced.

"The model of a new boutique starting up down the street with two guys, two Bloomberg screens and two desks, doesn’t really stack up any more,” Brown says.

“Unless they are rock stars where they can, overnight, draw a lot of FUM to them from a previous house, it’s very, very unlikely that they can compete.” 

Where there may be more growth in the boutique market is in particular sectors that aren’t currently well-serviced, or where innovation could add value. 

“There is a lot of competition and innovation in areas servicing retirees. You get interesting boutiques like Plato, which has an income fund targeting zero taxpayers; we’re seeing concentrated funds, which is due to the fact that managers need to justify fee levels by being more active; and we’re seeing a massive thematic in the income space,” Green says.  

“If you’re looking for real originality, often the boutique can deliver quicker than the bigger guys, who tend to be 12 months behind.”