Does size matter in the investment world?

At the recent Raging Bull Awards held in Sandton, it was clear that size does not matter as Boutique asset managers outperformed many of their larger peers.

There is also a popular belief that bigger companies are more adept to coping with challenges and can add significant value to clients, but is this really the case for boutique firms?

When small goes big

Hardi Swart, Director of Autus Wealth Managers, points out that one of the benefits of taking a boutique approach is that these firms are most often owner managed, which means that the professionals who founded them are the ones who make the key decisions.

The word boutique is usually defined as an organisation serving a sophisticated and specialised clientele. In order to run this organisation practically in the field of investment management, structures and processes are required to enable this organisation to make quick investment decisions which will be beneficial in a volatile market.

“Smaller organisations also count when making investment decisions. In the world of asset management, flat structures and unhindered flow of information is an aide to decision-making. Larger organisations that have experienced exponential growth often become labored by their size. These companies also become limited to invest mainly in the Top 40 shares on the Johannesburg Stock Exchange (JSE) when they reach a certain size of assets under management.

By contrast, boutiques may consider the entire range of 400 companies on the JSE main board. Acquiring a meaningful stake in a well-managed mid-sized company, like Curro for example, can bring exciting opportunities to investors.

The boutique advantage

A robust investment process, a wider investment choice, a desire to succeed and a personal investment in a business can give boutique managers an edge over larger competitors. Autus Chairman, Christo Malan points out that boutique firms can be selective and consider companies that are not necessarily in the JSE Top 40, as this can add substantial value for investors.

“A boutique can offer its clients a more personalised service, which means that boutiques are better able to meet client’s needs.

Boutique managers walk the talk

Boutiques are typically owner managed with committed investment professionals involved in the organisation and the control of such firms generally is in the hands of the investment professionals, who help to ensure the firm’s investment DNA is protected from outside influences and dilution. Such firms also have small investment teams with investment professionals who have a genuine passion and belief in the investment philosophy.

In most cases, these managers are willing - and do - limit the pace of growth in assets preferring to concentrate on the alpha generation rather than asset gathering. Boutique managers tend to be asset managers as opposed to asset gatherers. Portfolios also display some common characteristics.

Typically, they are more concentrated with fewer stocks held and often have a smaller to medium cap focus. This leads to higher levels of active risks and active shares, two important components in the
alpha generation.

Eating at home

There is evidence which demonstrates the advantages of investing with boutique asset managers.

In a study of US mutual funds, Baks, Busse and Green (2006) showed that the average fund held 128 stock positions, but the top-performing funds held less than half that number. This leads to the obvious question about risk; do concentrated portfolios lead to the increased risk of portfolios? The evidence suggests not.

One needs to examine whether or not the manager is building a portfolio with enough uncorrelated shares to diversify away companyspecific risk, but not so many shares that the portfolio starts hugging the market.

Paradoxically, active managers hoping to reduce their risks by running portfolios with a large population of shares actually increase the risk that their funds will underperform the benchmark after fees, trading expenses and other frictional costs, such as the bid-offer, spread.