Better performance, higher fees, but boutique funds are
worth it, reports Barbara Drury.
Boutique fund managers burst onto the local scene just in time to
tap into investors' fury over the big McFunds charging fat fees for
negative returns. Now that returns are improving at the super-sized
end of town and some boutiques have grown fat with success, it is
worth asking whether there are fundamental differences between the
two.
Five years ago there were half a dozen boutique managers. There
are now close to 50. After several years of rapid growth, boutique
funds account for about $40 billion in funds under management. That
compares with just $29 billion at June 30 last year.
In 2003 boutique managers produced the best returns in the
business, according to figures from Mercer Investment Consulting,
and provided four of the top five Australian equities funds.
Figures from research firm Morningstar (see table) show that in
the 12 months to May many boutique funds continued to outperform the
relevant index.
It is hardly surprising, then, that boutique funds are the
flavour of the month.
But the rush to cash in on the boutique trend means some managers
will inevitably fail. As the table shows, many funds have been
around for less than three years and investors would be wise to hold
onto their money until fund managers have a track record.
The reputation of most boutiques tends to rest on one key,
highly-skilled individual, such as Peter Morgan at 452 Capital, Kerr
Nielson at Platinum, Robert Maple-Brown at Maple-Brown Abbott and
Anton Tagliaferro at Investors Mutual. Highly skilled stock pickers
are essential, but that holds true for mainstream managers too.
As Anthony Serhan of Morningstar points out, just because someone
has performed well at a big fund does not necessarily mean they have
what it takes to run their own business. Even the most talented
individuals need a good support team.
In a recent presentation Serhan argued that too much time is
spent trying to define boutique funds on a technical basis. Instead
he prefers to highlight their essential features, such as ownership.
At Platinum the principals hold 100 per cent equity, while at
Investors Mutual the level is about 50 per cent. At some funds it is
much less.
Serhan says ownership is a good proxy for fund stability. That
is, fund managers who have a stake in the business are more likely
to stick around and to create a pleasant working environment (see
case study).
To be a successful niche player you need a clear and distinctive
style, whether it is a growth or value bias, a focus on a particular
market sector or adherence to a benchmark or absolute return. This
applies equally to the big players.
When Peter Morgan left Perpetual to run his own fund, he cited
the limitations of size as one of his reasons.
One of the criticisms of big funds is that they have so much
money to invest it is difficult to find sufficient really attractive
opportunities. Boutique funds tend to be quicker to close their
doors to new money once they reach an optimum level. Morgan also
argued that big funds miss out on opportunities to invest in good
smaller companies because they can't buy a big enough stake to make
an impact on their overall fund performance.
Yet in many instances, boutique funds look remarkably similar to
the opposition at a stock level.
Morningstar compared the wholesale industrial funds of Investors
Mutual and Perpetual and found similarities in the number of stocks
held, sector weightings, the proportion of total funds invested in
each stock and the market capitalisation of those stocks. Five
stocks appeared in the top 10 of both groups.
As long as boutique funds continue to put performance runs on the
board, there is little need for fund managers to discount fees to
attract business. In fact, boutique funds can charge a premium for
their products and most do.
Base fees are only marginally higher than the average, but the
real slug comes in the form of performance fees - usually a
percentage-based fee for beating a pre-determined benchmark.
Serhan has no issue with performance-based fees provided they are
fully disclosed. He would, however, like to see fund managers make
up for any previous underperformance before they take another
performance bonus and maybe even consider reducing fees when they
lose money, as some of their US counterparts do.
High five When Dean Fergie worked as a portfolio
manager for a big institution, he spent up to 40 per cent of his
time in meetings. Now he heads his own boutique fund, OC Funds Management,
with a full-time staff of five. The working day is more an informal
meeting of minds.
"Now we can focus on making money for clients," says Fergie.
OC launched two funds in December 2000, aimed at retail
investors with a minimum of $45,000 to invest.
As the table below shows, the Premium Equity Fund has averaged a
return of more than 20 per cent a year for the three years to May
31.
In many ways OC is cut straight from the template for a groovy
boutique fund. The group is 100 per cent owned by staff and four
external directors, who all have their own money invested in the
funds.
"There's a lack of office politics, and [there's] the extra
accountability and responsibility that comes with ownership," says
Fergie.
OC has also tapped into the mood by aiming for absolute returns
- that is, making a profit rain, hail or shine - and making part of
its fees contingent on performance.
OC aims to generate an average return of 10 to 15 per cent a
year over rolling three-year periods. It takes 20 per cent of excess
performance above 15 per cent on top of management and other fees of
1.8 per cent. If the fund has a really bad year, it will defer a
performance fee until the slack is made up.
"Some funds aim for 1 to 2 per cent above the All Ords, but we
don't believe clients should pay for average returns," Fergie says.
Unusually, the investment team doesn't specialise and the funds
aren't restricted to any sectors or investment style. In practice,
though, they tend to invest in smaller industrial companies in the
belief they are easier to understand, simpler to value and more
accessible to research, with better opportunities for growth than
the heavyweights.
At present Opis has $130 million under management and Fergie
plans to cap the funds at between $300-400 million. He says anything
above that level would make it difficult to sustain returns. Each
fund is restricted to 25 to 30 stocks and never holds more than 7.5
per cent of the listed value of a company or invests more than 11
per cent of the portfolio in any one stock.
"That's one of the main differences with smaller boutiques -
we're not managing billions of dollars so we don't have to take
large stock positions that make it hard to get out if things go
wrong," says Fergie.
