Boutique investment firms vs large asset managers – weighing the options

Entering into the stock market is often one of the biggest decisions that a person has to make. Many options are presented, and one can often feel overwhelmed when facing the possibility of making this decision alone.

There has been an increase interest in boutique asset managers over the past 18 months and this article hopes to convey the good, the bad and the ugly of both boutique managers and larger managers.

Getting access to markets

The reason for the increase in interest in boutique asset managers can be traced back to a few key factors. Firstly, many of the big managers have reached capacity or are near capacity and are either soft closing or hard closing their funds to new investors. Investors have now turned to the smaller managers to get access to the markets.

Secondly, many advisers and consultants are looking to differentiate their offering to clients. They have turned to boutiques to offer them solutions that differ slightly from the plain vanilla managers traditionally used.

One of the major attractions to smaller managers is also that some of these smaller managers have been able to show consistent outperformance or alpha over the past three to five years. The main reason is that the funds are generally smaller and therefore more flexible in ability to take an over or under weight position relative to the big houses.

Boutique fund managers generally own a big percentage of their business and their own personal wealth is often also invested into their products. These managers have skin in the game and are therefore incentivised to generate performance and manage risk.

Boutique fund managers also do not have any career risk in that they will not get fired for making a wrong call. It is therefore easier for these managers to be benchmarked according to their business principles and avoid mental herding mentality.

Keep the negative factors in mind

There are also some negative factors to bear in mind when considering boutique managers. Generally, smaller boutiques do not have the same financial or human capital resources available than bigger managers, and business risk is higher when investing with a boutique.

There are a number of risks that one takes when selecting a boutique fund managers. The risk of one person making the investment decisions with a limited team of research analysts, can be significant and needs to be taken into consideration.

If the fund manager is unable to manage the funds for whatever reason, investors can be left in a difficult position. There can also be a lack of segregation of duties between the fund manager, the risk manager and the compliance manager with the fund manager often being responsible for all three roles.

There can also be a lack of resources such as systems, procedures and policies. Generally, these risks are prevalent when investing with a boutique manager provided that the returns are good. It is only when there is a problem with the fund, or the fund manager, that these issues come to the fore.

Don’t forget the liquidity risk

A number of small managers can also have liquidity risk where a single investor has contributed most of the business’ assets. Should this investor redeem his assets, the fund manager can often find that there is insufficient cash available and positions will need to be liquidated to generate sufficient levels of cash often negatively affecting performance.

Boutiques can offer investors an alternative to the big managers. It is however very important for investors to consider the amount of additional alpha that some boutiques can generate relative to the increased business risk that some of these managers carry.

In our next article we will cover the details of what the due diligence document should cover.