Global exchange traded fund (ETF) flows hit a record $1.5trn last year, smashing previous records. The global ETF market is now five times its level of a decade ago, at $13.8trn. The vogue for passive investment is undimmed, and is likely to continue as long as the index heavyweights in the US technology sector lead markets. Is this a challenge or an opportunity for boutique asset managers?
Once seen as the optimum structure to deliver investment returns, boutique asset managers have faced a tougher environment more recently.
Sebastia Stewart, chair of the Independent Investment Management Initiative, which represents more than 50 boutique firms, said: “Boutique investment companies have been under increasing pressure in recent years. The rise in demand for passive strategies has been the most notable cause, resulting from combination of strong index returns, concentrated in particular securities and underlying sectors to which many active managers have been underweight, consolidation among the fund buying community requiring more scalable investment solutions; and an obsession with reducing costs.”
The rise of passive funds haven’t been the only problem. In the UK, the rise of MPS and the problems of implementing it on platforms have led MPS providers to gravitate to large, liquid funds.
There are boutiques that have this type of fund, such as Evenlode and Fundsmith, but more often they are likely to be off-radar for discretionary fund managers compiling MPS. There have also been regulatory challenges, with the rising cost of compliance hitting boutique managers particularly hard.
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Some boutiques have struggled. Somerset Capital, for example, wound down after losing its large St James’s Place mandate. Ardevora, Crux and Tellworth have all been absorbed elsewhere. The failure of Woodford Investment Management did little to enhance the reputation of the boutique, even though many of its problems were unique.
Stewart said: “Public scandals, including relating to Woodford and Odey Asset Management, have exacerbated the flow of assets away from boutiques towards bigger brand names and passive alternatives as investors seek to avoid reputational risk.
“Wrongly, the idiosyncrasy of these issues is too often overlooked. This coincides with an era of lower risk appetite overall, from the turbulence and uncertainty of the Covid years, followed by structurally higher interest rates, that investors and markets are still digesting.”
Continued popularity
However, fund managers continue to set up boutique managers. Ben Whitmore and Kevin Murphy have left Jupiter and Schroders to launch a value boutique. There are also plenty of boutique success stories, from Polar Capital, to Premier Miton, to Evenlode or Fundsmith. It remains a preferred structure for free-thinking fund managers who want to unshackle themselves from the constraints of a large organisation.
For investors, boutiques still have appeal for those who want differentiated, highly active, capacity-constrained investment strategies. They remain popular with discretionary fund managers, who believe boutique fund managers may be in a stronger position to deliver alpha than some of their larger peers.
Ben Mackie, senior fund manager at Hawksmoor Fund Managers, said he likes boutiques because individual accountability is high, and decisions can be made quickly and efficiently. They are also likely to have ‘skin in the game’, with remuneration structures that align investor and manager interests.
Discretionary fund managers may also see it as a differentiation point over the range of commoditised options elsewhere. It is difficult to set themselves apart if they simply follow the herd into index funds, or the largest active funds.
A boutique moment?
After two years of high index returns, it could be a moment for boutique managers to come into their own. Dan Brocklebank, head of UK at Orbis Investments, said the concentration of global stock markets into a handful of companies is a risk for investors.
It’s not only passive investments that are concentrated in these names, he said, but larger investment management groups have also gravitated there as well.
“Boutique managers offer a valuable antidote to this market environment. With unique strategies and the ability to find value in smaller market segments, blending exposure to boutique managers with mainstream portfolios can help advisers provide the true diversification clients need,” he added.
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Stewart agreed: “There is plenty of compelling evidence, and maths, to suggest that the greater the adoption of passive strategies, the greater the level of pricing inefficiency and the easier it will be for active managers to outperform. While the last few years have certainly tested this theory, these have been exceptional times to which the industry is adapting, and this does not mean this relationship doesn’t hold true in the long term.”
Nevertheless, investors need to navigate boutique strategies carefully to avoid a Woodford experience. Where investors are accessing boutiques through a discretionary management portfolio, there is less of an issue, with advisers relying on the DFM to do the due diligence, but where they are accessing boutiques directly, Brocklebank suggests looking for managers with strong alignment through co-investment, fee structures, or ownership structures.
“Knowing that a fund provider is most interested in how well the portfolio performs rather than how much it is able to attract in terms of AUM can reassure clients,” he said.
Boutiques remain the entrepreneurial end of the investment management industry and after some failures, there is an increasing recognition on what good and bad looks like within a boutique. Those boutiques that have thrived have tended to be those with the strongest governance and a clear story for investors.
The rise of passive has been a challenge for boutiques, but it may become a source of strength, with boutiques in a better position to navigate the increasing complexity of financial markets in the year ahead.
