I am very keen on investment platforms. I love the way they have disrupted the industry over the past decade. I love the simple convenience of being able to hold a huge variety of assets in one place and to have instant access to all the data I want about those assets. And I am very pleased at the way they have pushed down our investment costs. But they come with problems.
I have written about one of them here several times. If the platform is the technical, if not the beneficial, owner of your shares, how do you exercise your voting rights? And what does that mean for shareholder democracy? Hint: nothing good.
Another problem might be that we have become more interested in individual funds than in the firms that provide them. Before the advent of platforms (assuming you didn’t use an independent financial adviser) you bought direct from a fund manager. He grossly overcharged you, of course, and mostly still does, but it meant that, if you were the type of person who did any analysis on your purchases, you might consider the fund management firm in the round as opposed to just the one fund you fancied.
Buy boutiques with “skin in the game”
We don’t do that anymore. Each fund has become a standalone purchase bought for its own strategy. Take the mania of the moment: environmental, social and governance (ESG) funds. Does it make sense for investors concerned about these factors to buy specific funds dedicated to do-goodery? Or might it simply be better to buy only funds run by firms with high levels of ESG fully and enthusiastically embedded in all their systems? I’d say the latter.
The same might go for performance. Do you want to buy one fund that has done well over five years, or several from a firm running a selection of funds that have on average outperformed over a much longer time period? Again, I’d go for the latter.
With that in mind, I’d point you towards a recent report from US investment manager Affiliated Managers Group (AMG), called “The Boutique Premiums — the Boutique Advantage in Generating Alpha”.
A boutique fund management firm is defined here as one in which the principals in the firm have a significant amount of equity in it, holding a minimum of 10% and preferably more; in which investment management is the only business of the firm and managers that are part of wider platforms, insurers or banks don’t make the cut; have less than $100m under management (this sounds like a big number but is peanuts to some of the big boys); and are properly classed as active managers, so no fund-of-fund managers or “smart beta” offerings.
The report is mildly self-serving, since AMG’s business is to invest in boutique managers, but interesting nonetheless. The data shows that boutiques “broadly outperformed” non-boutiques in the 20 years to March 2018 and that this outperformance against indices was “persistent”.
Overall, says AMG, if you had invested exclusively with boutique firms over this period you would have made an extra 16% on average and rather more if you focused on value-orientated US small-cap strategies or emerging markets — which would have been nice. Their funds also outperformed their indices “more often than not”, something it is sadly impossible to say about the active fund management business as a whole.
AMG lists a variety of reasons for this, but they can be summed up as aligned long- term incentives, and owners and clients who are after the same thing. In other words, long-term outperformance and an enduring franchise rather than asset gathering for the sake of it.
The ultimate mini boutique
This thought brings me to my fondness for the investment trust sector in the UK. Because what is an investment trust but a mini boutique? Each is its own company, where the fund manager is simply hired by the directors to run the money. The directors have interests aligned with the shareholders.
Beyond a certain level that makes the fund investable and its shares liquid enough to trade freely, it makes no difference to them how much money is in the fund — they get paid a flat fee regardless — so they aren’t incentivised to gather assets for the sake of it.
They tend to invest in the trust alongside the shareholders they represent. Those that don’t are named and shamed in the Canaccord Genuity “Skin in the Game” report every year (it’s a very bad look) so they are incentivised to create the environment for good performance and in particular good long-term performance (board tenure is usually about eight to nine years).
No wonder then that investment trusts have a history of outperforming open-ended funds — by about 0.8% a year, according to research from Cass Business School.
It seems worth not just examining the fund and its strategy, but the structure in which it sits. Perhaps the best way for investors to proceed is to double up on these two bits of outperformance information and to buy investment trusts that have delegated their fund management to boutique firms. Artemis has a couple of these: the Mid Wynd International Investment Trust (LSE: MWY) is perhaps a good example of the genre. Others might be the trusts run by Miton, such as the Diverse Income Trust (LSE: DIVI) and the Miton UK MicroCap Trust (LSE: MINI) (disclosure: I hold these).
Finally, a quick mention of one would-be investment trust looking to raise money to launch at the moment. It is the Global Sustainability Trust.
It rather contradicts everything I have said so far this week. It is a trust, but the money itself is not to be managed by a boutique: Standard Aberdeen has been hired by the board to run the portfolio, which is focused on sustainability rather than performance and sustainability is embedded in the process — my preference.
But it is still a really interesting idea. The plan is to invest primarily in private companies that are expected to have a positive impact of one kind or another. There is, as far as I know, no other way for the retail investor to access this kind of unlisted company, something that makes its attempt to float on the stockmarket worth keeping an eye on.
• This article was originally published in the Financial Times