The idea that smaller, more agile boutique fund managers are at an advantage when it comes to performance is nothing new. Often, the more money a small, highly successful fund takes in results in the manager finding it difficult to maintain a liquid position in a small-cap stock or to seek out new opportunities. Remaining open to new investment too long can also change the fund’s profile as managers are forced to invest into larger companies to deploy growing investor capital. In this article, we look at three reasons why it pays to be nimble.

1. Ownership model

Boutiques have more freedom to manage money without having to follow a company-wide philosophy they may not support. Having generally started the business themselves, boutique owners have conviction in the investment processes that they have developed and a strong commitment to disciplined execution of those processes. They tend to be quicker and nimbler, with greater focus as less time is dedicated to the organisational politics of larger institutions.

2. Skin in the game

A boutique fund manager also has more skin in the game, which greatly increases their motivation to outperform. A fund manager with a personal stake in the boutique has everything riding on the success of the fund, including their wages, their savings and ultimately their job. By contrast, an employee at an institutional manager who has a mediocre year is not going to be nearly as worried.

An October 2020 study by Morningstar’s Director of Manager Research, Russ Kinnel, found that of the 7,424 funds in the United States, only 1,155 had managers with more than $1 million of their own money invested in the funds they were managing. This equates to only 15.5%. Coupled with Kinnel’s assertion that manager ownership is the second-best predictor of outperformance (after fees in first place), it literally pays to have skin in the game.

3. A numbers game

As a fund becomes bigger, then the quantum of money that needs to be invested in each stock grows. A small fund can easily buy and sell positions in large capitalisation stocks without having much market impact. However, a large fund that tries to invest in small capitalisation stocks is likely to experience some difficulty that impacts on performance. This means that as fund size grows, the universe of available stocks shrinks, because the manger has to cut-off the smaller market capitalisation opportunities, which in many cases may be the best opportunities.

For example, a 4% allocation of a $100 million fund requires a $4 million investment, which for a company with a market capitalisation of $800 million, would be a manageable 0.5% holding of that company’s stock. However, for a $2 billion fund, the same 4% fund position would require an $80 million investment and represent a substantial position in the company of 10%.

In practice, this means large funds tend to focus on companies in the ASX100 and their returns typically ‘hug’ the index. Smaller boutique funds have a greater opportunity to outperform, although this isn’t a guarantee of success in its own right, and every investor should always do their own research before choosing the right fund manager for their own circumstances.

About Stuart Cartledge

You may be familiar with Stuart Cartledge through his quarterly listed market update in Insight. Stuart is the Managing Director of Phoenix Portfolios and the portfolio manager for each of the company's property portfolios. Prior to establishing the business in 2006, Stuart built a strong track record in the listed property security asset class and has been actively managing securities portfolios since 1993. Stuart holds a master's degree in engineering and management from the University of Birmingham and is a Chartered Financial Analyst.

About Phoenix Porfolios

Established in 2006, Phoenix Portfolios is a boutique equity investment manager which has built a solid track record across a variety of A-REIT mandates, property securities funds and microcap securities, culminating in numerous industry awards.
To succeed in the highly competitive investment sphere, Phoenix seeks to be experts in niche sectors of the market, including property, infrastructure and small/micro-cap stocks. Phoenix’s rigorous focus on in-depth research provides a knowledge-based competitive edge.
Phoenix is jointly owned by staff and Cromwell Property Group. Joint ownership coupled with co-investment stakes in the funds Phoenix manage, promotes long-term stability and a strong alignment of interests between the employees and investors. Cromwell is an active participant in direct property markets and provides valuable insights into the Phoenix research process.
Phoenix has outsourced all non-investment functions to specialist providers, enabling the team to focus solely on investment activities.