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The independent boutique advantage

Nic Andrew

The debate over the value proposition of active management has intensified over the past few years, particularly against the backdrop of increased market volatility, writes Nic Andrew (pictured), executive head at Nedgroup Investments.

Research from AMG shows independent active boutique managers have outperformed both non-boutiques and passive indexing over the last 20 years.

The research also showed that the highest excess returns occurred during years of elevated volatility, which suggests active security selection works best when the market consensus is uncertain. This is when the experience and skill of individual stock pickers really shines.

What sets this independent boutique investment manager model apart is a number of persistent features, chief among which are the entrepreneurial ethos with partnership orientation and investment-centric organisational alignment.

Identifying these uniquely positioned managers and partnering with them has been a central part of the company’s strategy and success over the years. Therefore, Nedgroup’s manager selection process is built around the following Seven Golden Rules:

Alignment of interest:

Managers should not only invest alongside their clients but also have material equity ownership in the business.

A boutique structure that is founded by the rationale of sharing equity ownership of business and investing with clients is key to a successful and long-term partnership.

An investment focus:

Managers must be investment-led rather than marketing-led. Nedgroup looks for boutiques with investment autonomy and low levels of bureaucracy as they are much more likely to attract and retain top investment talent.

As funds scale, they become less liquid, as their holdings become larger and therefore harder to sell. This, in turn, can become a hindrance to boutique firms that built their success on agility and responsiveness. 

Additionally, scale can bring capacity problems in terms of personnel – a fund which succeeded based on a certain small number of great individuals has no guarantee of translating this success to larger AUM category when they have to hire a large number of new analysts. 

Flexibility:

Managers need to have the ability and willingness to execute active positions. This requires having a good sense of the capacity in their strategy, and if it is necessary to cap a strategy to protect existing investors, a boutique should be willing, if not eager, to do so.

This issue has been illustrated, in part, by the recent troubles of Woodford Investment Management which has big stakes in many of its holdings, meaning a decision to exit a stock can drag down the share price if executed too fast.

Downside protection:

Nedgroup’s research has identified that between two-thirds to three-quarters of the outperformance delivered by top managers comes from their ability to protect capital in negative markets.

Interrogating a manager’s approach to portfolio construction and what happens if their base case does not actually realise are critical to understanding how they protect on the downside.

Long-term orientation:

Thinking long term is both about the management of portfolios, which can be seen in lower turnover and costs, and in how a business is managed. It is a critical mindset to have to help with continuity and multi-generational succession of key investment personnel.

Passion:

Negroup has never found an exceptional manager who does not live, sleep and eat “investments” and isn’t obsessed with delivering exceptional long-term performance for their clients.

Clear articulation of edge and conviction:

The best managers know what they are good at and can articulate their edge clearly and have shown conviction in sticking with their philosophy through various market cycles. A good way to test this would be to reread the manager’s historical investment commentaries, particularly during years of underperformance.

The combination of these factors sets the really good managers apart from the rest and is why Nedgroup prefers boutiques.

This article was written for Expert Investor by Nic Andrew, executive head at Nedgroup Investments.

Part of the Bonhill Group.