It may sound fashionable to be invested with a boutique asset manager offering high-quality goods, but like a high street shop that closes its doors when you are most in need of a special outfit, small specialised managers are no good if they can't stay afloat in all markets.
Whenever mention is made of boutique managers, the ghosts of asset managers past are mentioned in the same breath. The likes of Prodigy, DMG Asset Management, Velocity, Infinity and Greenwich - managers that started in the 1990s bull run and vanished around 2000 when market conditions turned against them.
But there are a number of managers who started out at the same time and are now rather successful: The likes of Oasis Asset Management, Frater Asset Management and African Harvest.
Some people also argue that managers such as Coronation and Investec started out as boutiques.
Now there are a number of new kids on the block. However, not all of the new names in the unit trust listings are boutique managers. A number of new funds have been launched by financial advisers or brokers.
Both boutique managers and brokers usually operate their unit trust funds under other management companies' licences - known as white labelling - beyond which are big differences.
Paul Stewart, the chief investment officer of Plexus Asset Management, says in the case of broker funds, the funds are targeted at the broker's clients and are a result of the financial intermediary building his or her own brand and increasing the fee he or she can earn from his or her clients. They either manage the assets in the funds themselves or outsource this function to an investment manager.
The experience these brokers and advisers have in managing your money varies widely. A boutique manager, Stewart says, is usually a well-known asset management guru who moves out of one of the large asset managers and sets up on their own, hoping money will follow their name.
They often don't do much to market themselves or get investors to buy into their funds, preferring to rely on the good names of their key managers.
Although Frater Asset Management is often called a boutique, James Frater, the managing director, says Fraters does not regard itself as a boutique manager, but rather as a small manager. A boutique, he says, is two or three guys setting up shop and outsourcing everything other than managing the assets. Fraters has always done its own portfolio administration.
Fraters recently applied for a licence to operate as a unit trust company and switched its funds over to its own licence in November last year. This will enable Fraters to service its clients better, although it will still outsource some client administration, such as sending out statements.
Both Frater and his brother William are key players in the business. Their father, Kenneth, who was the chairman of Simpson McKie Inc before it was bought out by HSBC, was also one of the founders of Fraters.
James Frater worked at Allan Gray and later co-founded Oasis Asset Management with Adam Ebrahim, before launching Frater Asset Management.
But for other asset management stars who have set up on their own, the boutique label sits more comfortably. Piet Viljoen, who left Investec in 2003 to start Regarding Capital Management or RE:CM, is a good example.
Viljoen has 18 years' experience in managing assets. He was responsible for keeping the Investec Opportunity Fund, the asset manager's flexible asset allocation fund, at the top of the performance tables for many a quarter.
Rory Maguire, the chief operating officer of RE:CM, says RE:CM is not unhappy about being called a boutique manager, but if a distinction is made between a boutique manager and a small manager, then RE:CM is the latter.
RE:CM has 13 people who manage client and administration relationships and it has its own branded offerings in the same way that Fraters does.
Tim Allsop, who managed the once top-performing Syfrets Prime Select Fund from 1995, is another example of a boutique manager. Later Allsop and Anthony Sedgwick, who was also at Syfrets, teamed up again to manage the successful African Harvest Rainmaker Fund.
The Prime Select Fund had then become part of the Nedbank stable, but its performance was lacklustre. Nedbank's investment arm, now Nedgroup Investments, asked Allsop if he would take over the fund again as an outsourced manager.
Then African Harvest decided to concentrate on managing and developing the retirement fund side of the business, rather than its unit trust business.
Nedbank was rationalising the funds it had acquired through the mergers of BoE, FTNIB and NIB, and Allsop and Sedgwick suggested that Nedbank take over African Harvest's unit trust business, including the Rainmaker fund, and outsource the management of the Rainmaker fund to them as boutique managers. This led to the creation of Polaris Capital three years ago and the merger of the Rainmaker and Prime Select funds, which Allsop and Sedgwick now manage.
The third partner in Polaris Capital is Marius van Rooyen who had worked with Allsop at Syfrets. He then spent two years establishing a hedge fund management business at Brait, known as Brait Specialised Funds. When Van Rooyen left Brait to move to Polaris, he brought with him the hedge fund he was managing, which has been renamed the Polaris Hedge Fund.
One of the newest boutique managers is Aylett and Co, started by Walter Aylett, who was the manager of Coronation's worldwide flexible fund, the Optimum Growth Fund. Aylett, who set up shop in the middle of last year, has been given the mandate to manage Nedbank's new worldwide flexible fund, the Bravata Worldwide Flexible Fund.
Frater said his family started Frater Asset Management because they had faith in their ability to manage assets and knew they could add another dimension to client service that larger businesses were not providing.
Maguire says Viljoen set up RE:CM because he recognised the need for a business that places the investment needs of the client above all else.
An element of frustration with being part of a large asset manager motivated Allsop, Sedgwick and Van Rooyen to set up Polaris Capital, but the main reason for doing so, Sedgwick says, was because it was the next logical step.
Aylett, on the other hand, says he wants to paint his own canvas and decide what colours to use.
Nedgroup Investments has helped both RE:CM and Polaris with an instant source of funds, by outsourcing the management of its funds to them, and it has assisted Aylett by setting up the Bravata fund and giving him support to start up. The funds are marketed, sold and administered by Nedgroup Investments. More than two years ago, Nedgroup Investments adopted an approach of outsourcing the management of its funds to what it describes as "the best of breed".
The approach has worked well for both the boutique managers and Nedgroup Investments. For the quarter to the end of September 2005, Nedgroup Investments had climbed significantly in the Plexus survey of management companies' performance to third place after Coronation and Investec.
Nic Andrew, the head of Nedgroup Investments, says managers leave established management houses to set up shop on their own because they want to manage money in the manner they believe most appropriate, whereas at a large investment house might be constrained by the house's philosophy.
The other reason they leave is the potential to earn significant wealth. High-profile and successful managers are well remunerated, but they are often able to achieve significantly higher rewards in running their own operations, Andrew says.
"Offshore, the explosion of hedge funds has taken this to the extreme, where reports of top boutique hedge fund managers earning hundreds of millions of rand in a single year are not uncommon," he says.
If you ask anyone in the asset management industry to name boutique managers or list the characteristics of them, they usually pick small managers or list the size of assets under management as a defining feature.
A small manager with a lower amount of assets has greater flexibility and fewer investment constraints, Andrew says. As a result, the manager has a larger investment universe, he says.
This is particularly relevant in South Africa, where the number of local securities in which a manager can invest is limited, and the liquidity of these securities further constrains the investment universe.
Andrew says that as a manager's assets increase, it is unable to take meaningful positions in mid- and small-cap shares (without taking on greater risk, particularly the risk of the share not being liquid should the manager wish to - or worse still, need to - sell its holdings). He says the mid- and small-cap sectors are often less researched and mis-priced and offer managers who can invest in these shares the potential to add value.
While the manager who wants the greatest flexibility needs to stay small, Andrew says a manager needs enough assets under management to ensure their business is profitable, and able to support the required infrastructure to make quality investment decisions. The amount of assets required is normally in the region of R3 billion to R5 billion.
For managers who invest in South African equities, Andrew says the top level seems to be around R10 billion to R15 billion. Beyond that, the opportunities reduce dramatically. However, he says, this is dependent on the style adopted by the manager and does not apply to fixed interest or passive managers.
Terence Craig, the chief investment officer of Frater Asset Management, agrees that the bigger a manager gets, the more its investment stance is compromised. See graph here. The bigger the funds under management, the more a manager will track an index, such as the JSE/FTSE All Share Top 40, or take risks with big bets on big shares.
Craig says that to take a position in a share and invest eight percent of the fund in it, a fund with R500 million would have to invest R40 million in a particular share. A fund of R5 billion would have to invest R400 million and a fund of R50 billion would have to invest R4 billion. To invest R400 million in Netcare, you would have to buy 2.6 percent of the company's shares. To invest R4 billion in Netcare, you would have to buy 26 percent of the company.
Such a large stake would not be available on the market, nor could you sell it, Craig says, and Netcare is the 34th largest company in the All Share index when shares are ranked according to their free float market capitalisation (the value of all the shares of the company that are available to the investing public).
There are only 109 companies in which a R5 billion fund can take a five percent stake, while a R50 billion fund would be able to invest in only 31 companies, Craig says. For this reason, Fraters plans to remain a small manager. It currently has R7.5 billion under management and plans not to take more than R15 billion in equities.
Among the newer boutique managers Personal Finance spoke to, RE:CM has strong ideas on how much a boutique manager should manage.
Maguire says RE:CM currently manages R4.5 billion and expects to reach R5 billion soon. He says RE:CM could manage between R7 billion and R8 billion of equities, which means that RE:CM would have about R10 billion, because some of its mandates are balanced funds, which also invest in cash, bonds and property.
"If you are managing so much money that you have to create competing products and/or you end up tracking the index, then you are managing too much money. Managing over R15 billion of equities seems problematic to me - although you would be a small manager in South African terms."
Sedgwick says Polaris has R13 billion of assets under management and intends to stop taking money at some point, but it is difficult to draw a line in the sand and say where, because the number dates quickly.
He says when Polaris started in 2003 they thought they would stop at R7 billion, but now two-and-a-half years later, they have R13 billion.
However, R7 billion in 2003 is more than R17 billion in today's market terms.
Sedgwick says he believes the optimal amount of money for Polaris Capital to manage (in November 2005 terms) is probably around R16 billion or R17 billion.
"We do want to stay a small and focussed team giving good service and we cannot therefore expand indefinitely."
Aylett says he does have limits, but they are specific to the mandates of his clients and he intends to remain a small manager. He does not think there is a limit to the amount of money you can invest offshore, but locally the amount a manager can invest in equities must be around R4 billion to R10 billion, he says.
Aylett says the advantages of being small, and particularly very small in the offshore market, are that when you want to, you can quickly buy a stake in a company and you can quickly dispose of it.
Established asset managers have generally been around for a while and that's why we are happy to trust them with our money. But how do we know that the relatively new boutiques will survive?
Andrew says big and small businesses have very different business risks.
Small businesses' primary risk is not attracting sufficient assets to survive, while a biggest risk of a large house is probably losing existing assets and managers. "Small managers live and die by their ability to out-perform - a mediocre small manager, with no distribution or marketing budget, will soon be relegated to the history books," Andrew says.
The larger managers, on the other hand, are often more concerned about not under-performing their peers. This "looking over the shoulder" syndrome has resulted (with a few exceptions) in most of the larger managers having remarkably similar portfolios and returns, he says.
Larger managers often disparage boutique managers by asking where they would be if their key asset manager left. But Andrew says that although it is counter-intuitive, the key manager risk is often lower in a small house than it is in a large one.
"This is because the key investment professionals usually have significant equity (and often a large percentage of their net wealth) invested in the businesses," he says.
They are unlikely to leave in a hurry. The larger risk in a boutique, Andrew admits, is that of the star manager who decides to enter the Red Bull Big Wave challenge, and doesn't judge his take-off correctly. The success of a boutique often hinges on a single star manager, and if that manager suddenly died or was disabled, the business may fold.
However, as long as you have invested through a unit trust fund you cannot lose your money, even if the manager's business fails, Di Turpin, the chief executive of the Association of Collective Investments, says. A unit trust fund's assets - shares, bonds, and cash - are held in trust on your behalf and cannot be used by the manager to solve its financial problems.
Turpin also says that if a boutique manager is operating on a third-party licence, it means there is a bigger and potentially more experienced company backing the manager. If the boutique fails, the bigger company will be responsible for taking over the asset management, and any other aspects of the business that the boutique was handling.
Although your fund will then have a new asset manager, you will not have been jeopardised in any way by the demise of the boutique asset manager - apart from any potential under-performance that may have happened, Turpin says.
Frater says some of the failed boutique managers of the 1990s started with big cheque books and did not match the cost of their teams to their assets. And their investment philosophies were dependent on a market cycle, he says. When that cycle turned, their funds floundered. He says Fraters has a proven investment philosophy, has grown with its clients, and the wealth and reputation of the key stakeholders depends on the success of the business.
The Frater family, the directors and the staff of Frater Asset Management own 75.5 percent of Frater Group Holdings, the holding company that owns Frater Asset Management and Frater Unit Trust Management Company. Outside shareholders hold the other 24.5 percent of the company.
All RE:CM's staff have invested their own money in the business. "We could think of no better place to put our own money and the business savings. Our savings grow in the same proportion as our clients' and are invested on exactly the same terms," Maguire says. The business is also owner managed.
Sedgwick says Polaris is owner managed with no outside shareholders. He says the business does not need capital, but all the staff have committed significant investments in the Rainmaker and the Polaris Equity funds.
Aylett says Aylett & Co is both owner-managed and it has two outside shareholders who have bought a stake in the company.
All the staff share in the profits and so, indirectly, they all have a stake in the company, Aylett says. If they want to invest, they can only invest in unit trusts that Aylett & Co manage - they cannot run their own portfolios alongside those of the clients they work for. Aylett says all the major role players have invested a significant portion of their personal wealth in the business.
Large asset managers can employ many analysts, and research the markets and individual shares in which to invest. But does this mean that boutique managers do not have enough staff to make good investment decisions? Seemingly not.
Andrew says there is no clear answer to the question of how many people you need on a research team. As evidenced by the success of investment guru Warren Buffett, many of the world's best hedge fund managers and some of the top local managers, large investment committees are not a prerequisite.
In many cases, he says, group-think slows decision-making, reduces individual flair and results in lowest common denominator output.
He says that it is an ironic twist that in response to the demand for the "alpha-generating" boutique managers, large houses have in many cases set up specialist sections and funds.
And the big houses have capped these funds (rather than the house) for performance reasons.
RE:CM employs two analysts and Viljoen is the portfolio manager. Maguire says RE:CM only considers high-quality securities that are worth more than what it pays for them. He says once securities that don't fit that requirement are excluded, the breadth of their research is "more than adequate. Our approach to research is very deliberate and focused and is a strong competitive advantage for this reason."
Maguire says few investment teams have the comfort of such a strong focus. The fact that RE:CM's assets are small enough to give it a competitive edge in terms of investible universe, means it would make no sense to under-resource on research.
Polaris has four people doing its research, including the three partners, and it contracts out some of its work to freelance researchers. Sedgwick says Polaris does not think it is necessary to have a large research team. He says the South African market is over-researched and you can buy good research from stockbrokers - especially on the large market cap stocks.
Aylett says he employs two researchers in addition to himself, and they focus on investments where they think they can add value: "We do not need to look at everything the market has to offer. Also we have a very good network that assists us."
Frater Asset Management has two portfolio managers, Frater and Craig, and eight analysts.
Frater says if you have a large research team, members of the team are usually responsible for a sector or sectors. They then stop looking for investment opportunities and instead develop a vested interest in seeing their sector represented in the fund.
Sedgwick says he does not think all the boutiques that have launched will last. But South Africa does need boutique managers because there needs to be greater fragmentation of the asset management industry to keep it healthy.
Currently, the top five large managers (by market value of funds under management) control an unhealthily disproportionate amount of the funds invested in the South African equity market, he says.
Andrew says there are good and bad, large and small managers and you should avoid bad small managers like the plague. An unskilled small manager is very dangerous. But if you can find a talented "boutique" manager who is incentivised and passionate; displays the ability to make tough decisions that are in the best interest of clients (such as capping their business); has a robust investment philosophy and process; and the track record through various cycles, then you will do well to consider entrusting some of your monies to this David, rather than some Goliath of the industry.
This article was first published in Personal Finance magazine, 2nd Quarter 2006. See what's in our latest issue