Institutionalization Threatens Boutique Firms

New research by SunGard Financial Systems has found that the increasing burden of compliance is creating barriers to new boutique asset managers and squeezing the margins of existing managers. The report identifies the growing issue of ‘institutionalization’ at the boutique end of the asset management as the main concern facing smaller managers and a serious threat to innovation and entrepreneurialism.

According to the research, 53% of firms identified institutionalization, including the burden of due diligence and compliance, as the ‘make or break’ factor for them over the next 12 months.

The regulatory and compliance requirements in the fund management industry which were originally designed to protect investors may in the long term work against them by limiting choice and innovation.

“The irony here is that boutiques pose less systemic risk than large institutional managers, yet due to the high cost of compliance and a proliferation of regulation they are the ones under greatest threat,” said Ed Lopez, executive vice president in SunGard’s asset management business. “So while the ‘too big to fail’ firms continue to raise assets, boutiques run the risk of being ‘too small to succeed’. This matters to all investors as it is the boutiques that drive innovation and are often able to offer a more cost-effective alternative to investors.”

Similarly, ‘the ability to show institutional grade control systems’ has also become a bigger component in deterring new entrants into the sector. In short, it is more expensive and more burdensome to launch an asset management business today, thus discouraging the very thing that defines a boutique: entrepreneurialism.

The SEC’s Form PF requires advisers to report the use of leverage, counterparty credit risk exposure, and trading practices for each hedge and other private fund managed by the adviser. In the summer of 2012, the Commission began to receive the first set of Form PF filings from the largest advisers of hedge funds and other private funds, and received a complete set of initial filings from all reporting advisers earlier this year.

“The hedge fund industry has raised concerns about the confidentiality of Form PF data,” said Norm Champ, director of the SEC’s division of investment management, in a September 12 speech. “However, I can reassure you that the Commission takes the protection of the confidentiality of this information very seriously.”

Some of the world’s most successful fund management groups, such as Jupiter and Carmignac Gestion, started as small boutiques. The SunGard research indicates that these industry leaders might never have been formed if the current regulatory environment prevailed in the past.

“For boutiques the options are limited. They need to be more focused and self-aware as they navigate their way through this regulatory uncertainty,” Lopez said. “They must invest in technology, improve their operational efficiency and look seriously at outsourcing their compliance function. For smaller firms these are potentially costly decisions, which will erode margins further.”

The report shows that 92% of boutique asset managers polled believed that technology would form part of the solution to meeting these demands, the other options being either to hire in-house compliance staff or outsource the compliance function both of which would significantly impact margins.