Charlotte Moore looks beyond the familiar story about the advantages of the multi-boutique model, and finds that setting one up is easier said than done, and that some of the supposed benefits are contested
Investment management is a quixotic affair. There have been many attempts to add mathematical rigour and industrialise the process but success is often still more of an art than a science.
The investment industry has realised that asset managers do not get better when they get bigger. This is especially true for active managers; bigger often means mediocre. Boutique firms are a better bet.
Investment firms often become victims of their own success. Once the assets under management balloons, making successful investment decisions becomes much harder.
It becomes more difficult for the junior analyst with a great idea to get heard at a larger firm. And the firm can no longer make money out of smaller companies because the size of the firm means that it can now only invest in large-cap companies.
Larger firms often ask their managers to do more than they did when the company was smaller. Diversification might be a great idea for balancing the risks in an investment portfolio but it is not a good way to get the best out of a fund manager. Fund managers’ investment styles are a direct reflection of their personality.
Jonathan Little is now founding partner at Northill Capital, which provides equity and seed capital to start-ups and early-stage asset managers, but he was previously head of all the non-US businesses at the BNY Mellon Asset Management multi-boutique.
“Spend 10 minutes in a room with either a number of quantitative macro fund managers or a group of special-situations equity managers, and you’ll immediately notice that they are completely different personality types,” he says. “Making them manage a style of fund that is outside of their comfort zone is disastrous.”
As a firm grows in size, it becomes more institutionalised. The staff loses its sense of ownership of the firm and motivation drops. The culture changes and the shared vision fades.
Political frictions also start to raise their head. Managers who perform well become resentful if their profits, instead of being used to expand their business, prop up others who have lost money.
This creates a conundrum for the big investment firms that want a large and successful asset management business. The solution that has evolved is the multi-boutique model. The idea is that a number of small boutique investment firms sit under the umbrella of the larger company.
“The multi-boutique model allows the firm to put clusters of people together that have the same investment philosophy,” says Little. “This model allows the investment manager to eventually build a successful $1trn firm by adding small fund manager operations that have total control over their own processes and their own profit and loss account.”
For this idea to work, however, there have to be some benefits for the fund manager in joining a larger firm. These benefits lie outside of the investment firm’s principal business areas. The two main areas are distribution and compliance.
If the fund manager is successful, it will want to expand its global reach and sell outside of its local market. But the expense is often prohibitive. Little says: “It costs a lot of money to set up overseas offices and hire all the necessary staff. It’s a very big gamble for a small firm.”
Money spent on infrastructure shrinks the funds available to spend on recruiting investment talent and improving returns, observes Curtis Arledge, vice-chairman and CEO of BNY Mellon Asset Management. “An investment firm is always trying to reduce those costs that are not part of delivering investment performance, and ultimately, their client’s success,” he says.
The costs of operating a fund manager have risen rapidly in recent years. Compliance has become a very large burden and those regulatory demands have knock-on consequences. The higher the expenses of the fund manager, the more capital the regulator demands the manager has to hold.
In the past, fund managers did not need many specialist skills to operate in a number of different markets. But regulators are now demanding they prove that they have the knowledge to venture into those markets. Product structuring is also much more complex.
Firms also need to demonstrate that they meet the necessary professional standards, which is yet another cost to shoulder.
Giving fund managers access to a distribution network can be very helpful. To build the business, a dedicated sales force working closely with the fund manager is vital.
Once the firm expands, however, access to a large sales force can be a real benefit. The firm might venture into countries a long distance away from where it is based or want to access a specialist market. The firm can take advantage of a sales force that has expertise in different markets. This sales force can work together with the product specialist. Rather than wasting time on 20 unfruitful meetings, the local sales force might organise only half as many, but with a greater likelihood that they will be successful.
These shared services have to be offered to boutiques in the right manner. “We don’t try to do everything for the boutiques. We focus on those services that are common to a number of our boutiques and that would cost them significant sums of money to set up individually,” adds Arledge.
Andrew Dyson, global head of distribution at Affiliated Managers Group, concurs: “Our afflilates asked for the shared services that we now offer them. They are under no obligation to make use of these services.”
Despite the increasing fund management cost burden, not every small boutique sees the benefit of becoming part of a larger investment house.
Anders Lindell, CEO and a co-founder of Informed Portfolio Management, says: “If a fund manager wanted to keep a lid on the costs of running the business, many of these costs, including many of the business processes could, in fact, be outsourced to a reputable administrator.”
Neither does IPM see any immediate benefits from the larger institutions’ marketing and sales expertise. “Our independence means that we can get access to whichever platform we like. We can also have much more focused meetings with our clients because we know our products inside out. We prefer to have a direct relationship with all our clients,” he adds.
Those in favour of the multi-boutique model, however, say that there are important additional benefits, other than cost control. Dyson says: “Our goal is to be a permanent partner for our affiliates, which means that we want them to live on beyond their founders. That can be a challenge.”
Successful investment management is so dependent on particular individuals that it is all too easy for a small boutique to implode once the founders leave. Helping the first generation to identify and nurture the next generation is a vital skill.
Dyson says: “It’s important to ensure that equity is passed on from the first generation to the second generation. We can ensure that this is correctly priced so that it works for all parties as well as acting as intermediaries in the process.”
Managing a successful multi-boutique model is not as straightforward as it might seem. It’s all too easy for there to be bureaucratic creep in large companies that can impose counterproductive measures that dissolve the necessary boundaries between the boutiques.
Little says: “This is why I’m sceptical about many larger fund management firms that say they are going to move towards a multi-boutique model. In reality, if the company has an amorphous fund management arm, then it is virtually impossible to introduce this concept successfully.
“The firm has to have a culture and heritage of managing the multi-boutique model. They must have an inviolable separation of each boutique’s P&L. The proportion of the profits that belong to the management team needs to be set in stone. The successful multi-boutique manager knows that messing with this system will destroy the business,” he adds.
There are different ways to ensure the correct separation of profits between managers. Affiliated Managers Group, for example, takes an equity stake in each of its boutiques but each firm operates with complete autonomy. Dyson says: “This structure ensures that there is no tension because our link is at the revenue level, not the profit level.”
A boutique fund manager that has a bad year will understand that it needs to reverse that situation. It will not understand, however, if its profits are used to prop up another fund manager.
Nor should a boutique that performs badly for a number of years be left to fester. The investment firm that runs a multi-boutique has to be prepared to be Darwinian about any badly performing firm and, if necessary, undertake a root-and-branch reform of that boutique.
To prevent performances from drifting, some monitoring may be necessary. BNY Mellon AM is big enough to warrant its own internal team that constantly assesses its own fund managers.
“Our internal research team monitors everything - from the investment performance to any style-drift, as well as evaluating new products. We think that this service is particularly appreciated by a number of our clients,” says Curtis.
Different boutiques should be viewed by management as competing businesses and the staff should be kept separate to prevent style-drift. If fund managers start to spend time together, they will inevitably influence one another and dilute their different investment philosophies.
Building a multi-boutique would be an academic exercise, however, if the clients were not receptive to the model. In recent years, clients have become increasingly in favour of using smaller, rather than larger, fund managers.
Dyson says: “Clients are very sympathetic to a boutique model. There is a reason why a growing number of big managers are increasingly claiming to be multi-boutiques.”
Little says that institutional investors have figured out that there are essentially two types of investment managers - those that gather assets and those that generate alpha. Big managers are asset gathers, while the boutiques generate alpha.
The relationship between a client and a fund manager is a more personal one at a boutique and there is greater scope for a shared investment philosophy. In contrast, large investment managers are too big for the client to have a properly personal interaction, so it is more difficult for the client to feel that its concerns and ideas are being heard.
Clients are very good at sniffing out those firms which are operating a true multi-boutique from those that simply pay the idea lip service. Little says: “The best way for a client to figure out if it is a properly run multi-boutique is to ask if the fund managers have an equity stake.”
The recipe for successful investment manager remains elusive. Cherry picking the best boutiques is an intelligent approach to building a large investment house. But making a success of the multi-boutique model requires a whole-hearted commitment to the concept that may simply be impossible at some institutions.