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December 9, 2016

Mutual Fund Concentration: Why We Need Boutique Funds

by Jake Moeller.

Recently in London, Investment Week hosted its “Funds to Watch” conference showcasing mutual funds containing assets of less than £300 million.

Whilst strictly speaking not all the fund groups represented were boutique houses (a number of large fund groups were promoting some of their smaller, less well-known funds), there were a considerable number of new and innovative mutual fund offerings on display.

Tough to differentiate

The mutual fund industry in the U.K. is largely characterised by its homogeneity. Fund analysts, selectors, gatekeepers, and multi-managers are skilled and adept at highlighting the not-inconsiderable differences in style and factor biases, size, and composition, which all contribute to the myriad performance outcomes we see in our performance tables. To the average “mum and dad” investor, however, one managed fund is pretty much the same as another.

Brand matters

Just as with any product, brand matters. In the absence of any other information, brand is a dominant factor in choosing a mutual fund. Investors might know of M&G or Invesco Perpetual because they see them advertised on the side of a taxi. That makes a conversation between an intermediary and a client on fund choice much easier than it might be if the product were Manderine Gestion or SVM, for example.

The U.K. fund market is highly concentrated. According to Lipper data, there are some 6,000 funds domiciled here. That is a lot of funds. Consider that the U.S. mutual fund industry has only around 8,000 funds in an industry that is over three times larger than the entire European mutual fund industry.

Exhibit 1. Concentration of UK Domiciled Mutual Funds (as at September 30, 2016)

Source: Lipper, Lipper for Investment Management (UK Domiciled funds only)

The total assets under management (as at September 30, 2016) in U.K.-domiciled funds are around £990 billion. That too is a reasonable sum, but 25% of the total is contained in only 50 funds. That is quite an astonishing figure. “Blockbuster” funds such as Standard Life Investments GARs, M&G Optimal Income, or Invesco Perpetual High Income are household names to most of us, and there are another 200 U.K.-domiciled funds with assets in excess of £1 billion each.

Adverse affects of concentration

Concentration matters. Large funds take increasingly larger positions and hold more lines of stocks or bonds than smaller funds. That drives them closer to an index position, making sustainable alpha a more difficult proposition. Additionally, liquidity can also become an issue if, for example, a huge fund suddenly needs to liquidate an entire line of stock on the back of an adverse corporate event or in order to fund redemptions.

Good things in small packages

Small funds are attractive for many reasons. They are nimble, they can–especially in their formative years–outperform their benchmarks considerably, and they often seek investment opportunities that are ignored or overlooked by larger funds. They are a great tool for diversifying a portfolio that might contain an unintentional bias to, say, large-cap FTSE shares.

The barriers to entry for a boutique are considerable, but they need to be given a chance to thrive. Gatekeepers need to freshen up their approved lists of the same well-known names. Large platforms and providers should consider fund additions that, although they may carry some reputational risk, ultimately invigorate and refresh the gene pool for all investors.

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