Can boutique real estate managers thrive in the current environment? Shayla Walmsley asks six industry players
ATP Real Estate
*Fund decisions determined by strategy, not size
*No necessary correlation between size and experience
*Investors are wary of larger managers' conflicts of interest
Size means little to Ville Raitio, partner at the real estate subsidiary of Danish pension fund ATP. He says ATP Real Estate has typically invested with larger fund managers over the past three years, but primarily as a result of its focus on core investments.
Investment decisions are made not on the basis of the size of the funds available but by strategy. Within any strategy, portfolio managers can choose between large and small funds.
"We're not really looking for large funds because they're large, but rather because they fit with our strategy," he says.
"If we're looking at core assets with large lot sizes, almost by definition we'll need a large fund for such a strategy. Similarly, if we're targeting large deals - distressed or otherwise - we'll need a larger fund."
Strategic concerns are also considered when the pension fund subsidiary invests with emerging managers. "For niche strategies, there might be a slightly stronger tendency to choose smaller managers, depending on the market or sector," says Raitio.
In fact, he believes the size of the manager can be misleading, pointing to those examples where a smaller manager has longer experience in a specific area. Conversely, the more capital a fund manager has the more pressure he or she could be under to invest it.
"Fund managers might not be as selective in their investments as small managers of specialist funds," he says.
Further conflicts of interest may exist for larger managers using the same resources to execute the same strategy for a fund as for a separate account, for example.
"But you can quickly understand if there is such a risk," says Raitio. "We would require exclusivity - for the manager not to invest in another fund while an existing fund is still going."
*Size no proxy for performance
*A ‘range of performance' in both size categories
*Investors follow the manager, not the house
There is no measurable relationship between the size of the manager and returns delivered on assets under management, according to Ian Cullen, co-founding director at Investment Property Databank (IPD).
"You'll get a range of performance in both cases," he says. "It would be amazing to see a consistent correlation between size and performance — not least because a large house will receive a broad spectrum of mandates, sometimes stronger, sometimes weaker."
But it would be equally wrong for investors to see boutique managers as somehow more specialist by definition. "You could argue that a larger manager has more access to expertise and resources," he says.
Access to resources is one benefit that might encourage an investor to choose a particular manager - for example, if a strategy requires intensive research that might not be available from an emerging manager. Another benefit is if an investor needs the support of complex financial structure. "A larger manager is more likely to have the in-house resources to deliver it," he says.
"It's a complicated question because the drivers of performance are a complex mix of market circumstances and manager intervention," adds Cullen.
"If a manager outperformed by 2% in a particular fund, the margin is to do with stock-specific factors. But location, lease structure - in fact, a whole range of things - are equally available to small and large managers."
Otherwise, investors will follow the manager, rather than the house. "The manager expected to deliver will be an individual, whether that's within a large or small fund management house. Investors want to know who the man or woman making the investment decisions is — and that's more important than the heavyweight strategy or the complex financial structure," says Cullen.
Knight Frank Investors
*Small managers are more attractive - but pension fund mandates are few
*Emerging managers' model best fits alternatives
*Decreased role for consultants benefits emerging managers
Head of Knight Frank Investors, John Styles, says pension funds have more appetite for emerging managers in response to consolidation in the big-manager market. But he acknowledges it is difficult to tell because of the infrequency of pension scheme mandates.
The emerging asset management business has doubled its assets under management over the past 12 months to £800m (€919.2m), mainly from existing clients. It has also won two new mandates, though neither from pension funds. One is a private Middle East family office investing in the UK and Western Europe, a mandate worth £700m (€799m), £200m of which has already been deployed. The other is an advisory management service for a pooled fund managed by Santander for high net-worth investors.
Knight Frank, which is openly pursuing pension fund mandates, believes investors will use emerging managers for alternatives because of their specialist knowledge. "Pension funds are likely to use specialists in specific asset classes, such as hedge funds and private equity - in other words, for alternative asset classes rather than for global equities," he says. "It fits the model better."
Yet Europe is still some way behind the US trend for major US public pension funds to set up emerging manager programmes. "The funds are not on the same scale by a factor of 10 or more," he says. "Pension funds are looking to specialist managers but they're unlikely to set a specific programme for it."
The decline in the use of consultants is one positive trend for smaller managers, whose clients are more likely to select larger managers. Pension schemes with £1.5-2bn in assets focus on direct investment and take a more active role in choosing their own managers, says Styles.
"The fact that the consultant role is diminishing - even if they still have a key role in the process - is a good thing for us," says Styles. "Investment consultants have formal and rigid process, and are often reluctant to go with smaller managers."
*Investors now favour ‘strategic' over multiple manager relationships
*Smaller managers find partners to share costs
*Investor decision-makers do not want the blame for poor performance
Nabarro partner Jonathan Cantor attributes consolidation in the market to investors streamlining their costs through ‘strategic' rather than multiple relationships. A decade ago, a pension scheme might have had relationships with 20 fund managers, spreading its net wide with a diversified portfolio. "That model isn't so popular any more," Cantor says.
"Having multiple managers is time-intensive. It's more streamlined, and it keeps costs down, for investors to have strategic relationships with fewer managers, with the ability to secure favourable terms and a Rolls-Royce service as a result."
The beneficiaries of this trend will be very large fund managers offering diversity, with substantial in-house resources and the ability to buy in expertise. Yet there's also an opportunity for "smaller, leaner, more focused fund managers with specialist knowledge to catch mandates and launch funds".
Survival will depend on how fund managers deal with the costs of regulation. "Bigger players are able to cover the problem more easily because they have scale," says Cantor. "You might see consolidation at the level of smaller fund managers as they tie together to share the cost of regulation."
Costs are increasing as a result not only of more regulation and greater investor demands. Cantor points out that when fund managers were delivering double-digit returns, fewer requirements were made of them. "As performance declined, investors demanded increased transparency and reporting on investments, and that inevitably takes more time and resources," he says.
The same dynamic that encourages investors to demand more reporting more often makes them more likely to select well-established fund managers with a well-known global brand.
"Safety first is an issue. With an established manager, there doesn't seem to be so much of a risk," says Cantor. "If an investor goes to a less established fund manager and it doesn't succeed, the finger will be pointed at the people who made the decision to invest. That may impact on the ability of funds managed by smaller managers to launch successfully."
*Emerging managers require more due diligence
*Core funds will struggle but ‘the enterprising spirit burns'
*There is no large/small dichotomy, just a different model
European regulation - notably the Alternative Investment Fund Managers Directive (AIFMD) - makes business more complex for smaller managers. But "the enterprising spirit burns strongly", says David Boyle, executive director at Morgan Stanley Investment Management.
In fact, he rejects what he sees as a dichotomy between large and small fund managers. "An ‘emerging' manager could mean an established manager who has focused exclusively on London office for the past 15 years," he says. "It's not a dichotomy, just a different model. You'll still get single asset-by-asset plays, or funds with 10 assets specialising in German office or Silicon Valley, for example. Those funds tend to know which building they want to buy."
How small managers capitalise themselves is changing. Those who previously financed themselves deal-by-deal will have to rethink their financial model - though they will still be able to act quickly and with discretion.
"If they're not making money on the front end but they still have to pay overheads and their teams, they could be losing money now," says Boyle. That's especially true for core and core-plus funds, which could struggle more because they rely on base and acquisition fees, while the promote expectation is smaller. They're not making money on the back-end. You need scale for core. It will continue to be dominated by bigger managers," he adds.
In the meantime, investors - especially small ones - considering committing capital to emerging managers and specialist mandates are exposing themselves to reputational risk, he says - and they need to have the resources to mitigate it.
"It's a trade-off. You have to do a lot of work and institutional investors are not geared up for it," says Boyle.
"You need a pretty sophisticated, well-resourced team to do the due diligence. If you're the size of Morgan Stanley, you're probably only a phone call away from someone who's done business with them. That's not the case for a small investor."
*Larger managers must gain global traction
*‘Multi-boutique' model captures divergent advantages of safety and agility
*The new model makes it easier to award specialist managers
An alternative to the debate over large managers versus specialist boutiques is to combine the two models, in what Richard Tanner, managing director at AEW UK, describes as "a powerful, robust and vigorous mix" of both.
In the current market, large fund management houses have little option but to gain global scope as client portfolio strategies demand diversification. In contrast, smaller asset management operations may incentivise managers by the deal - or a small group of deals.
"The [deal-by-deal] model is well suited to boutique managers because they can make money with a small number of assets," he says.
The demand for global reach has become more acute over the past five years as fund managers' clients - pension funds and insurers - have looked at global allocations to real estate at the same time as international investors have moved to the UK and down the risk spectrum. "What does that mean for us? It means we need a global framework," says Tanner.
Combining global scale with a boutique style in a ‘multi-boutique' strategy, AEW UK says, gives fund managers "strategic agility with consistent branding" - and it gives clients the flexibility of a boutique-style within a global framework.
The impetus, he adds, is global client capital seeking both specialism and scale. "I'm a huge believer in strategies that really are multi-boutique — global access with a nimble approach," says Tanner.
"Boutiques are more focused and more nimble. But larger firms offer safety and larger distribution."