Star managers and investors still see the appeal of boutiques but barriers to entry are increasing

17th November 2013

Boutique fund houses can prove very popular with investors – keen to get a share of early performance or access to a star fund manager freed from the shackles of bigger fund groups. But as regulation of fund management gets tighter, there are signs that smaller groups could be losing out. Cherry Reynard examines the issues.

Moves by some of the industry’s top managers – Neil Woodford, Tim Russell, Chris Rice – to set up their own boutique asset management companies would appear to be a ringing endorsement for the structure. These managers seem to believe that the boutique structure gives them the opportunity to manage investor assets perhaps with a freedom not available to them at the larger houses.

Investors often flock to these new ventures if a manager has an established and successful track record.

Yet the boutique structure is under pressure on a number of fronts. The first is from regulation.

The sheer weight of regulation from the Financial Conduct Authority is challenging for smaller companies.

A number of fund management groups have commentated that the FCA’s current clampdown on the use of client money to buy research and other services from brokerage groups may threaten the boutique sector.

The New City Initiative, a London and Paris-based think tank has said that while it welcomes greater transparency, the FCA should stop short of an outright ban.

Magnus Spence, chairman of the NCI, says: “We would also warn about the risks to smaller firms of imposing a ban on using client money to pay for research. This would be bad for the UK fund management industry as a whole because it would be unable to take advantage of research to the same extent as investment firms in Europe and the US. A worst case scenario could even see the collapse of many smaller firms in the fund management industry.” Smaller firms tend to be more reliant on external research because they do not have nor can they afford large in-house analyst teams.

The FCA requirement that all clients with the same investment needs receive the same investment portfolio has also created some problems for boutiques.

Some wealth managers have taken a literal interpretation of the rules, saying that if they cannot buy more units in a good fund for a new client, they will sell all the units in a fund for existing clients.

This creates problems where a fund is soft-closed and may also work against smaller funds which often rely on wealth managers for seed money.

Being small also increases, the Total Expense Ratio of a fund because its fixed costs are higher. This comes at a time when costs are increasingly under scrutiny.

It suggests that funds may have to be larger to be properly viable, which in turn means that fund management start-ups contain greater risks.

Finally there is also a possibility that a host of regulations facing advisers may make them more reluctant to select boutiques. Advisers are already unwilling to select funds without a three year track record. But they face reams of requirements about risk and capacity for loss. Finally more advisers may go ‘restricted’ where they may tie up with fewer fund groups rather than retain their independence.

These issues may have contributed to boutiques falling behind the larger houses in terms of fund flows. For example, the most recent IMA Asset management survey showed boutiques have grown funds under management by 3.9% over the past 12 months compared to an industry average of 7.9%.

Also, boutiques were particularly vulnerable to performance-led fund flows. The best performers grew their assets by over 60% year on year, while the weaker portfolios saw outflows of around 40%.

However, few disagree that it remains a good way to run money. Managers generally seem to perform better when freed from the shackles of management responsibilities and collective decision-making. They also, almost invariably perform better when they are running fewer assets.

And there are boutique companies doing extremely well. In its latest set of results, trade website Fundweb, Liontrust reported net inflows of £315m over the past six months, up from £189m a year earlier. It also reported a rise in adjusted pre-tax profits of £326m. Although this is an established boutique, it shows that the structure can still draw cash from investors if it has the right set-up.

Gary Potter, joint head of multi-manager at F&C Investments and co-manager of the F&C MM Navigator Boutiques fund, says that he believes there will always be a place for quality investment talent and when they launch boutique fund groups they will be sufficient fund buyers to support them. He says: “Boutiques are a useful addition to the model portfolio madness. While some wealth managers are gravitating to larger funds, there is a huge opportunity for managers such as Rice, Russell and Woodford. The cream rises to the top and it is a good opportunity for us to buy in when they are running fewer assets, and are focused exclusively on investment returns.”

Boutiques have the same investment advantages that they have always had, but the regulatory climate has acted against them. It will make it more difficult for those boutiques but those with stars should still prosper.

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