Bellmont Featured in Financial Standard Magazine

posted on April 7th, 2015 by David

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Bellmont’s Peter Bell was recently interviewed by Alex Burke of Financial Standard. We have reproduced the article here. If you would like to reference the original article please see the images below.

Hamish Douglass, Roger Montgomery, Kerr Neilson, David Paradice, Tim Samway, John Sevior, Anton Tagliaferro, Geoff Wilson. These are some of the leading lights in the local investment market. What they all have in common is finding huge amounts of success with the boutique investment house model.

Boutiques, though no consensus exists on exactly what the term means, are perceived to have stronger performance, better investment talent and closer alignment with investor interests. Financial planners and institutional investors have a love affair with the model spanning decades.

Although large multi-managers were gaining pace on boutiques by buying them up around five years ago, recent research from Rainmaker Information seems to confirm boutiques have gotten their mojo back and justified their strong reputation: they’ve achieved excess returns of 1% or over relative to segment averages across the one, three, and five-year periods to 31 December 2014. Furthermore, boutiques outperformed international specialist managers and “big brand” comprehensives by over 1% on average over the past five years.

Queen Street Partners founder Dr Steven Vaughan has made a career of analysing, consulting on and even building investment portfolios of investment boutiques. To him, the reason the structure continues to endure is all about control.

“Super funds, retail investors and gatekeepers like asset consultants have become convinced over the years that the boutique model aligns the interests of clients and investment teams very well,” he explains.

“Investment professionals in these smaller, more nimble houses have control over their processes and the autonomy to make good business decisions that offer long-term stability.

It’s also no secret that the star managers with large amounts of equity in their own boutiques can also end up very rich and this is one of the key draws for talented investment professionals working within the confines of an institutional house.

The BRW Rich 200 list of wealthiest Australians contains several names that have found fortune through the model. Platinum founders Kerr Neilson and Andrew Clifford are perhaps the most famous examples at 10th and 193rd on the list respectively with an estimated combined net worth of more than $3.5 billion. Boutique fund managers Peter Cooper and David Paradice and Investors Mutual founder Anton Tagliaferro also feature.

But with so many success stories it’s all too easy to forget the challenges that small investment houses face and those who have succeeded warn against a “me too” attitude.

Vaughan says one of the most important things for new fund management businesses to be mindful of is growing too fast.

“There are many examples where fund managers have got very popular very quickly,” he says. “Once they are hot then the money tends to flow to them and that can be a problem. In saying that, most of the boutiques launched in the Australian equity space have been careful to avoid that in the last 20 years.”

The other headache managers face is how to cope with larger clients. “Larger investors have lots of capital to deploy and don’t want to deal with lots of fund managers – they don’t want to manage lots of relationships,” says Vaughan. Likewise, he adds, super funds don’t want to be a boutique’s only client and boutiques don’t want only one client.

Then are the instances where things have gone awry. Vaughan picks out the example of van Eyk, which fell over when one of its underlying managers was found to own a non-compliant, illiquid investment.

“There’s a perception that smaller firms, with their strong focus on investment might not have the same focus on governance that institutions have or will out-source,” he says. “There’s no doubt that we’ve seen a ramping up of governance requirements in recent years as driven by regulation. There’s greater attention paid to operation due diligence and monitoring. Larger houses have the scale to do that more efficiently.”

Despite these challenges Vaughan has made a career of focusing on boutiques and insists they are just as relevant as ever before, especially for high net worth and family office investors who tend to commit smaller amounts of capital than larger institutions and for longer timeframes.

“They still have a big part to play. It’s still a very attractive business model, so much so that very large fund managers cling to the boutique label.”

Lift off

Contrary to popular belief, boutique firms don’t start with a blank sheet of paper and a romantic set of ideas. The latest addition to Australia’s large collect of boutique fund managers, Antipodes Global Investment Partners, started three months ago, when Platinum deputy chief investment officer Jacob Mitchell resigned from star manager Kerr Neilson’s firm.

During more than 14 years at Platinum, Mitchell was a portfolio manager of the flagship Platinum International Fund. He also had responsibility for the Platinum Unhedged Fund (Jan 07 to May 14), achieving 6% per annum outperformance after fees and for the Platinum Japan Fund (Jan 08 to Nov 14), achieving 10% per annum outperformance after fees. With that strong track record he is confident he has the skill to deliver. But achieving success with an investment boutique hinges on so much more than pure performance.

“From when I left school I’ve wanted to manage global equities. I’ve always been willing to back myself as an investor and I have the track record. I’m at the point where I want to build a team,” he said when he announced the launch of the business last month.

Mitchell and the six people in his team will manage concentrated long only and long-short global and Asian equity portfolios. If other boutiques’ experience is any indication, ahead of them lie years of excitement and most likely a few challenges.

To Plato Investment Management managing director Don Hamson, talking the steps of leaving a large institution is not easy and it tends to include “an element of frustration.” Hamson was head of Asia Pacific active equities at State Street Global Advisors (SSgA) when he decided to leave and set up Plato.

“Large institutions have more red tape, they are not that flexible and they have strict standards on things like the type of computers or the number of screens that you can have,” he notes. In 2006, Hamson went after “the motivation of building something yourself, of being your own boss” and set up Plato.

Instead of doing everything himself, Hamson looked for the support of the Pinnacle Group, which calls itself a “boutique of boutiques”, and provides managers with distribution and other support services. “It was good to know that there were people looking after our IT, the compliance, the license… things that if you decide to do them by yourself can become completely mindboggling.”

Within three months, a team of three people could “focus on what we had to do. Pretty much from day one we were managing money and building portfolios.”

Despite the romanticism behind the idea of the manager who decides to set up his own business based on an investment philosophy and years of experience, Hamson says that for Plato the reality was quite different.

“We underestimated how long it would take to get out there and to get people to trust us. There are people who want to back you from day one, but there are others who prefer to put their money in big institutions or that want to wait for one or two years and see how you go,” he says.

The challenge became even greater when only two years after launching Plato the global financial crisis struck: “The GFC was the most difficult part by far,” Hamson says, but he adds that it helped him understand “people are not going to give you money just because you are a boutique.”

Incidentally, Mitchell’s new investment boutique has launch with more than $200 million in assets under management, having acquired Perennial’s international equity business. This shrewd move was designed to leap from the tricky start-up phase and give the group the critical mass to build a track record and win more clients.

Turning back to Plato, the Australian equities manager has had to fight hard to differentiate itself from dozens of managers out there. “You learn quite quickly that people choose you because you have quality products, because you do innovative things that maybe you wouldn’t have been able to do if you were working for a large institution,” he says.

Plato’s edge he explains, is “the focus on running money with a strong tax focus. People who invest in our funds are retirees, people in the pension phase market. You need to look at what the client wants, at their risk profile. You need to focus on thinking from the end client perspective, which in a way is easier when you back your own fund.”

The blank sheet of paper

Just how do ambitious portfolio managers go about setting up their own shop?

“A blank sheet of paper is a good place to start,” says Airlie Funds Management managing director David Cooper. Former Treasury Group managing director, Cooper partnered with his old colleague and head of equities at Perpetual, John Sevior, to launch Airlie Funds Management in 2012.

“John and I used to work together at Perpetual. When I left, we kept in touch. We both had good relationships in the market and we both had done a reasonably good job at our previous companies. So at some point we sat together in front of a blank sheet of paper and that’s where it all started,” Cooper says.

To him, one of the keys to success was to partner with someone that was philosophically aligned with him: “Don’t do anything you’re not good at and make sure your client is the winner. If you can build a business around a client, then you’ll have a good business,” he says.

But even then the challenges are still there: “you need to invest upfront; you put your money into the business before you draw anything out of it. Then you need to get the licence and put all the pieces together: systems, operations, human resources… and you need to do all of these things well while continuing to be relevant to the client.

“It basically means that you need to have a fully functioning business before you even have a business!”, he adds.

Despite Sevior’s reputation as a stock picker, he warns portfolio managers considering opening their own ship that “nothing is a given”. He adds their contacts in the industry were “enough to convince people to have a meeting with us. But it is not given that they are going to roll up.”

Cooper still remembers the anxiety of the first year, where “you need to make sure you are going to be relevant to your clients, that your clients think you are doing a good job.” However, he appreciates “the freedom to have a nimble culture and to set up your own systems the way you like it.”

The Airlie Concentrated Share Fund has returned 14.51% in the 12 months to end of February and 61.21% since inception in October 2012. At the moment, the fund is closed at seven institutional investors, while the retail strategy aimed at high net worth individuals is also closed at 200 investors.

The slow path to distribution

Hunter Hall global equity portfolio managers Jack Lowenstein and Chad Slater decided to leave the manager and to set up Morphic Asset Management, a boutique business that would have “a closer focus on risk management,” Lowenstein says.

Excess returns relative to segment averages

“The best way thing about starting a boutique is that you do it with a clean sheet, you’ve got no legacies at all. And if you have a clear vision of what you want, you can build a very successful business,” he adds.

Lowenstein and Slater started Morphic “with the confidence that we could pick stocks well,” but with the challenge to do so in a “more risk-managed framework.”

Being a global equity boutique meant “we didn’t have the same attention from the media as Australian equities managers.” Focusing on retail investors rather than institutional was another difficulty.

“We decided to go to independent financial planning groups and we were impressed by the quality of their financial advisers,” Lowenstein says.

Getting on the large institutions’ approved product lists (APL) was much harder: “It is a tougher task because these groups have more barriers, more committees, but we’re slowly getting through those as well,” he adds.

So far, the Morphic Global Opportunities Fund holds $105 million and has been listed in the Macquarie and the BT wraps. BT-owned Ascalon also bought a stake in Morphic in August 2014.

“Once we reach $1.5 billion in funds under management we’ll be cautious. We’d rather work at a small scale and deliver excellent returns because we’ve seen too many businesses die from greed,” Lowenstein says.

Alignment of interests

One of Mitchell’s key areas of focus in his new business is the alignment of his investment team’s interests with those of his end clients, recognising the best results only come from the best talent and only then if they are incentivised optimally.

To that end Mitchell has recruited two analysts from Platinum, James Rodda and Rameez Sadikot, and is joined by four investment professionals from Perennial’s business. Mitchell is also looking to add more talent to the investment team in due course.

Crucially, the investment team own 77.5% of the business and Mitchell advocates giving equity and profits away to staff as a means of remuneration.

“Alignment is a key part of this business,” he says. “It doesn’t guarantee results but is a pre-requisite to getting on the field. I want a performance culture. My vision is to build a ‘next generation’ investment manager that celebrates the role of the analyst and places investment performance at the heart of everything we do.”

Thirty percent of all profits go to staff regardless of how long they have been there, he explains and each member of the investment team is measured on their contribution to the group’s overall investment performance over three years. A portion of staff remuneration is also deferred and invested back into the funds.

This emphasis on alignment of interests also explains Mitchell’s preference for performance fee mandates.

Mitchell said the funds are likely to be more concentrated than Platinum’s portfolios but will have a similar focus on the Asian, particularly Chinese, consumer. One specific investment opportunity he highlighted was LCD glass, which is likely to be helped by a weakening Japanese yen. He also backs mature technology stocks in the US such as Microsoft and Cisco which are compelling cheap next to alternatives in the space and benefit from strong management teams.

Mitchell’s investment acumen is the key reason Pinnacle (“boutique of boutiques”) chairman and managing director Ian Macoun is so excited about Antipodes’ future, but it also highlights a pivotal challenge for anyone involved in the boutique model: key person risk. In other words, if so much of the boutique’s investment performance comes down to the natural talent and proclivities of the individual investment manager, what will happen to clients’ fund if they leave?

Macoun, also the founding chief executive of QIC, believes the problem is based on a misunderstanding of what a “boutique” is. “To be honest,” he says, “I’ve never really liked the term. It implies small. Kerr Nielson left BT and started up his boutique, and the term kind of stuck, but what it really means is a specialist investment management firm majority-owned by the investment professionals. But boutiques can be very large and have a big team behind team.”

Pinnacle – and Perennial before it, which Macoun also founded – is a case in point. A pioneer of the “multi-boutique” model in Australia, Macoun established Pinnacle as a means of letting a suite of talented investment professionals “do what they do best” while offloading administration and distribution duties (what Macoun calls the “back-office functions”) to the larger umbrella entity.

“A boutique is inherently fragile,” he admits, “so the multi-boutique is the best of both worlds.” He describes the ideal as “supported independence”, explaining investment professionals set up an environment that’s suited to their philosophy. “And they focus completely on their clients and producing good investment returns,” he adds.

“The other functions – your back-office infrastructure, or whatever – are also important and need to be done to a very high standard, and need their own set of talented people. Often, though, they aren’t the same sort of people as the investment professionals. And even if they were, it’s still not the best use of an investment manager’s time. We have an actual economy of scale on those functions, so they can be done by people across a number of boutiques – that’s the most efficient way.”

At the same time, he concedes that it’s difficult to escape the fact that boutiques are fundamentally personality-driven, “They do tend to be dominated by a small number of investment professionals,” he says, “but with our boutiques we have always focused on longevity and succession.”

Pinnacle’s boutiques, Macoun explains, operate based on a longevity model that ensures that baton can always be passed to the remaining investment team should the need arise. “Basically,” he continues, “equity gets recycled when key people leave. A lot of the organisations known as boutiques do have that major risk, and that’s not a good thing, so we sought to evolve the model that if the investment people cease employment with a boutique, they have to sell their equity back to the company to be recycled to other investment professionals coming through.

“And we’ve had a number of successions now. We’ve changed the MD of Hyperion, Solaris and most recently Palisade. And their equity was been sold back to other people in the boutique. As a result, key person risk hasn’t materialised.

“It can be a weakness of a boutique, sure, but it should never be a big weakness. And it’s also the main strength of the model: we’ve got a small number of talented people running these and they don’t have to report to institutional executives who don’t really understand their business.”

The other main ongoing challenge for a boutique, according to Bellmont Securities co-founder and director Peter Bell, is balance. Bellmont was created when its two founders – Bell and co-director David Montuoro – were 26 years old. Bell and Montuoro left broking and advisory roles to start up a boutique portfolio manager based on two key principles: direct beneficial ownership for investors (no unitised investment structures) and an entirely quant-based investment strategy using peer-reviewed academic research.

“It’s a unique model,” Bell laughs, “although I guess everyone thinks their business is unique. We’ve got a formula for how we work out which stocks we hold and what weightings we have, using quantitative systematic strategies. The reason we do that is because the opportunities we’re looking to exploit are generally caused by behavioural biases, such as the tendency to expect companies that have performed well in the past to continue performing well in the future, leading to them getting overpriced. Which then means their future returns end up being low on average.

“It’s very difficult as a portfolio manager to go against your natural tendencies, so we don’t give ourselves that opportunity. We have a completely rules-based investment approach. It’s based on academic research rather than the sort of research you get out of most investment banks, which tends to be very much self-serving.

“There’s a lot of research out there in academia that shows that there are certain ways to consistently outperform the market, and it tends to be very rigorous and robust because it’s been peer-reviewed, so there’s been a lot of opportunity to have holes picked in it.”

Bell says the biggest hurdle he overcame while building the business was reaching the right balance of scale. Initially, he and Montuoro had to find a partner for licensing and capital purposes – “We weren’t looking for someone who’d just milk us for a couple of years and then walk away” – and after that (and the GFC) the challenge has been growing Bellmont without losing sight of its specialist focus.

“The business is set up so that bringing on one extra client doesn’t introduce too many more incremental costs,” he explains, “and brings significant incremental revenue. So it means the business has wonderful operating leverage – every successive dollar of revenue flows increasingly straight through to the bottom line. But it’s quite a tough job getting to that scale.

“And then once you’re there, you have to simplify. Don’t try and do too many things. Focus on a limited number of things and do them well. I think that’s the biggest thing. As a boutique you by definition are a small business, and so you need to really focus your energies on those areas where you’ve got some sort of an advantage. So I think too many people try and spread themselves a bit too thin.”

A specialist investment focus also necessitates specialist fee structures so that clients maximise the benefit of taking a boutique approach to their portfolios. In Bellmont’s case, management fees range from 0.5% to 1.2% depending on the particular strategy employed and a client’s balance. “So for clients with over a million dollars,” Bell says, ” they can invest in our core equities strategy, with a direct account with stock held on HIN, and that’s managed for half a percent per annum.

“Because our approach is systematic, it’s very scalable, which means we’re able to be very much towards a low-cost end of the market in terms of fees. For smaller accounts we manage it through a managed account structure, because there are efficiencies in terms of brokerage costs and administration and reporting. And even some of our bigger clients are still perfectly happy to operate through that structure. They’re more than willing to pay the administration fee.”

From Macoun’s perspective, investors are generally happier with boutiques regardless of fees because of the security and reliability of the service. “I worked in institutions like QIC and Westpac,” he recalls. “Long-standing institutions which would survive a long time, but the people turned over all the time. And that was a great weakness. At Westpac, it was a game that we were out poaching each other’s people all the time! ‘I can get this person over there, you can get this person there.’ The clients hated it. “The boutique model works because there’s alignment of interests and people don’t need to leave. People have equity in the business; they’re going to stay there for decades. They have their home. And the clients love that. They want to back something they can stay with for a very long time.”

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