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Welcome to the new era of the funds manager

by Matthew Smith | 15 Jun 2016

Finding a way to house talent without stifling or spoiling it during commercialisation could be the biggest challenge for the finance industry (or any industry for that matter).

And there’s no better example highlighting this conundrum than in funds management. 

If institutions had their way, they would own the entire wealth management value chain — funds managers would sit neatly between product developers on the one side and distribution networks on the other.

And why the hell not? Institutions like to own asset management businesses because they have a high return on equity and are risk free relative to some of the other businesses they’ve owned in the past.

There are advantages for funds managers being part of an institution too — a good back office means more time spent on the real focus of managing money. Also, distribution helps to get money in the door to build scale.

It all sounds like a perfect fit, but that’s not how it works.

Independent streak

Good investors are bloody-minded and independent by nature, so they don’t tend to fit well within an institutional culture — they need to be able to make calls that can sometimes be at odds with other parts of a broader financial services, banking and advisory business.

Meanwhile, simply pumping money into a funds management business does not a successful business make; certain funds and strategies can only grow so large before their size impinges on their ability to outperform the market. Funds managers have to be incentivised in line with performance, which can sometimes mean lower profits at the end of the day, a quirk institutions have historically struggled to come to terms with.

Over time, institutions have tried different ways and structures to own and partner with funds managers to varying degrees of success.

Westpac Bank has sold down its stake in BT Investment Management. ANZ had its flirtations with asset management through joint venture partnerships that have come and gone, while National Australia Bank is forging ahead with its own boutique incubator model through wealth management subsidiary, MLC.

Commonwealth Bank possibly has the most fully formed internally managed funds management business of the big four banks in its Colonial First State Global Asset Management business; though, while CFSGAM is large, it tends to be pipped on performance by the comparatively nimble boutique managers. There are signs that CFSGAM is in the process of addressing this nexus between successful funds management and boutique structures — the firm is reportedly working on a separation of its small caps investment team from its broader Australian equities team to apparently manage capacity issues.         

Asset management businesses are attractive, but the large institutions find it difficult to separate them from advice businesses because the two go hand-in-hand within the vertically integrated model, which is now under threat of being broken apart as technology and regulation continue to evolve. 

House of boutiques

The most effective model for running an asset management business appears to be the so-called “house of boutiques” model, which provides centralised governance, marketing and seed capital in exchange for an equity stake to a series of small funds management operations. 

“Asset consultants and researchers are acutely aware of how distracting it can be running a funds management business … We want to see these investors managing money, not setting up and running a business, which is why the boutique incubator can work well,” David Wright, Zenith Investment Partners managing partner explains. Investors uses Zenith’s views on funds to decide which ones to invest in.

There is more of an alignment of interest in the boutique structure — they tend to have a performance fee structure in place tiered to restricting funds under management, whereas institutions tend to be asset accumulators.

A number of house of boutiques are home to some of the best-performing funds in the market, including the likes of Bennelong, Pengana, Grant Samuel, Challenger’s Fidante Partners, Pinnacle Investment Management and Macquarie Professional Series.

“There is more of an alignment of interest in the boutique structure — they tend to have a performance fee structure in place tiered to restricting funds under management, whereas institutions tend to be asset accumulators,” Wright says. 

One of the main challenges boutiques tend to come up against, Wright notes, is an inability to provide a succession path for new talent to come through the ranks and take over from the lead funds manager.

Last of the star stock pickers?

The modern funds management industry in Australia is built on a legacy of high profile successful stock pickers, leaving institutions and starting their own boutique investment firms to manage money how they see fit.

Value manager Maple Brown-Abbott pioneered the movement, but many other boutique firms, which are still going strong today, started in the same mould such as PM Capital, Platinum Asset Management, Airlie Funds Management, Magellan, Investors Mutual.

While many of these firms might not have needed to broach the issue of succession planning as yet, when they do Wright says they could be confronting the weakness of the model borne of the star funds manager.

“If you have the profile of a John Sevior [ex-Perpetual stock picker who started Airlie Funds Management] you have the ability to start a boutique on your own, but it’s rare, and it still doesn’t solve the succession issue,” Wright says.

Partnership model

The latest boutique asset management group to start up isn’t built around a star stock picker, rather it’s a “partnership structure”, set up by former CEO of NAB’s MLC, Steve Tucker, and former Perennial Investment Partners CEO, Lewis Bearman. 

From day one the boutique funds management network, named Prodigy Investment Partners, is designed to solve the problem of getting the second generation of funds managers equity in the business early to plan for succession, Tucker explains to FINSIA’s InFinance.

“It gets away from the star funds manager concept, it can exist on its own foundations of the business and ability to get equity in the business … With this structure we’ve tried to avoid pitfalls of the boutique model that as they mature succession becomes harder because people coming through have had to write bigger cheques and it’s all become quite complicated,” he says. 

The partnership approach is modelled off the accounting or legal profession, Tucker and Bearman explain, where revenue is shared and profits are distributed to partners in a tax-efficient way rather than equity ownership, which is common among the prevailing funds management boutique models. 

Tucker and Bearman have been in and around all of the different types of funds management structures over the last 30 years and both believe the business is destined to exist outside of institutional ownership. 

“There’s always been a tension that allows boutiques to exercise free will and make calls and get paid well when those calls pay off, compared to institutions where they need to mitigate risks. There’s a tension between that institutional culture and the culture of boutiques that means, over time, boutiques will thrive in this business,” says Bearman.


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