InvestmentsAug 6 2019

What future do boutique fund managers have?

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Last month, the US Department of Justice announced it would launch an anti-trust investigation into some of the leading technology companies, amid heightening concerns that a handful of market hegemons have become so dominant that they are stifling competition, leaving little room for smaller online platforms to participate, let-alone flourish.

The problem is not unique to the technology sector. The exact same problem is facing boutique asset and wealth managers, as a result of their increasing costs and the growing complexity of doing business, along with consolidation throughout the industry.

Right now, there is a bifurcation emerging in the asset management industry, insofar as the AuM (assets under management) divide between large brand name managers versus boutique providers has widened dramatically, as assets become increasingly concentrated in the former.

Right now, there is a bifurcation emerging in the asset management industry

Many believe this is a direct consequence of complex and costly post-crisis regulation.

Rules such as the AIFMD (Alternative Investment Fund Managers Directive), MiFID II (Markets in Financial Instruments Directive II) and PRIIPs (Packaged Retail and Insurance-Based Products) continue to cast a shadow over the entire industry, creating overheads which – while more easily absorbed by mega managers – tend to disproportionately impact boutiques, saddling firms with added operational costs and increasing the barriers for new market entrants.

The changing dynamics in the UK’s discretionary wealth management and independent financial adviser sector are also having a negative impact on the investment allocations to boutique managers.

Both the wealth management and IFA industry have undergone enormous consolidation as they too deal with regulatory complexity and increasingly look to obtain economies of scale. As investment assets are now being consolidated into much larger pools of capital, they can only be deployed into strategies and managers that are capable of accepting sizeable flows.  

Again, the largest fund managers, who are focused on asset gathering, can easily do this, whereas boutique providers - which tend to have specialist strategies, with higher conviction - are far more disciplined about capacity and the liquidity that they can offer.

Irrespective, this consolidation in IFA/wealth management circles is further inflating the AuM divergence between boutiques and mega managers.

As a result of these challenges, industry-wide M&A is now at its highest levels for a decade and this seems set to continue, further widening the gulf between large and small asset managers. This situation is neither healthy for the industry nor its end customers.

Firstly, excessive consolidation at the top prevents retail customers from accessing best-in-class specialist investment strategies. 

Less choice may prevent retail customers from obtaining proper portfolio diversification, which not only dents performance but amplifies risk too.

According to Willis Towers Watson, the largest 20 managers control 43.3 per cent or $40.6 trillion of the top 500 fund managers’ total AuM. Do we really want the UK’s nation of individual savers exposed to so few firms?

Secondly, as asset managers acquire scale, it becomes more difficult to generate performance as it is harder to access smaller, niche investment opportunities.

In addition, it is also trickier for these managers to trade without alerting the wider market to their movements. And finally, large organisations occasionally suffer from diseconomies of scale as a result of their complexity and friction between different business streams.

Even though scale may allow those larger managers to charge discounted fees, the returns – at least when benchmarked against boutiques – tend to be much lower according to Affiliated Managers Group. 

The study found boutique asset managers generated returns that were on average 62 basis points (0.62 per cent) better than their larger peers, and beat indices by 135bps (1.35 per cent) annually between 1998 and 2018.

The research added that investors with boutique-only exposures would have generated 16 per cent more wealth than if they allocated into mega managers over the last 20 years.

One of the main explanations they gave was that boutiques generally had more discipline in managing their capacity and specialised in fewer strategies.

In a recent speech, a senior representative from the investment management division at the US Securities and Exchange Commission (SEC) said the regulator was aware that industry consolidation and fee compression were potentially depriving ordinary investors from accessing small to medium sized asset managers, in what may be a precursor to increased scrutiny of M&A at large investment firms.  

Some boutiques argue that a more proportionate approach to regulation is required, as this will help reduce barriers to entry and further stimulate market competition. 

Others would take this further and have quietly indicated they would support some sort of consultation, review, or even a tacit intervention by either the Financial Conduct Authority (FCA) or Competition and Markets Authority (CMA) into asset management M&A activity and its consequences. 

A more radical idea, mooted by some, is to alter the mandate of the FCA entirely. 

The current regulatory objectives of the FCA are focused on market integrity, competition and consumer protection, all of which are critical, but perhaps an additional remit should be to promote or ensure the growth and success of the industry.

Competition is an essential ingredient for any industry to thrive.

If the UK is to retain its position as the pre-eminent leader in asset management, it must foster an environment where all businesses – irrespective of size - can prosper.   

With a new prime minister in place and Brexit looming, there is an opportunity to take meaningful action to ensure the UK achieves this.

Jamie Carter is chairman of New City Initiative