The chief executive at Principal Global Investors, a multi-boutique asset manager, met George Mitton in Monaco to explain why big firms are bad at original thought.
A diary mix-up – not mine, thankfully – means Jim McCaughan and his colleague Nick Lyster have been waiting for 30 minutes before I arrive for our interview, but if they are irritated by this they do not show it. Perhaps it helps that we are in sunny Monaco, at a cafe two floors above the conference centre hosting the FundForum International event. Amid the business meetings and corporate presentations, there is a holiday atmosphere in the air.
McCaughan, who is chief executive at Principal Global Investors, and Lyster, who is head of the company’s European business, are at the conference for the usual round of networking. Their company, which was spun out of US-based Principal Financial Group, is a multi-boutique asset manager with stakes in alternative managers, an emerging market debt specialist and real estate investment firms, among others. The firm has $289 billion (€216 billion) under management, but does not disclose how much of this is for its parent group and how much from third parties.
McCaughan maintains a quiet, polite demeanour during the interview. A Scot with a gentle accent, perhaps softened by many years spent in the US, he is not a brash, chest-beating captain of industry, more a kindly schoolmaster, albeit one with a keen eye on global trends in investment management.
His gentle manner does not stop him speaking some uncomfortable truths, however. “Investment management had about 30 years of virtually no change until the financial crisis. It was such a stable period, it made people complacent.”
The crisis shook some life into the industry, says McCaughan, which resulted in two trends: a move to passive investment in “core” areas such as large-cap developed market equities; and an increased demand among pension schemes for liability-driven investment.
Both trends are bad news for asset managers because the fees are low, he says. In his view, what had been the bread and butter of many asset managers – actively managed US equities, for instance – is no longer commercially viable. “I don’t think the active core is coming back and a lot of the industry is in denial about that,” he says.
Principal Global Investors hopes its business model will help it adapt to the new, tougher conditions. Set up in 2002, the company has 14 boutiques, nine acquired through acquisition, four created by organic growth and one, CIMB Principal Islamic Asset Management, which is a joint venture.
It deliberately does not try to assimilate its acquisitions, believing they function better if they are independent. McCaughan likes the management teams to have the same kind of incentives they had when they owned their own firms. There is a rationale behind this. He believes small asset management firms perform better. “There are diseconomies of scale in active asset management,” he says. “You don’t want to be big, because if you are you’ll stop performing.”
But why are small investment companies better than big ones? Capacity constraints are a factor, he says. “If you’re a successful active manager in emerging markets, and you get to $30 billion under management, you’re locked into your portfolio. You’re too big to make changes. That’s the main way diseconomies of scale come through.”
I say that asset managers can, of course, close their funds to new investment to protect the performance for existing investors. McCaughan says this happens “not often enough, it should probably happen more”.
He has other reasons for favouring small firms, namely that he believes they are better at original thinking. “Big companies are rotten at innovation,” he says. “By having all these boutiques, we’ve been able to have active management and creativity.”
What small asset managers often lack, though, is the capacity to distribute their products widely. When it comes to distribution, the economies of scale achieved by large companies are valuable, and this is what Principal Global Investors can offer.
“One of the things about the boutique structure is that it plays to the different strengths of investment management and distribution. If you’re going to have global distribution in fund management you need to be large. Distribution equals scale, yet that tends to mean mediocrity in investment management.”
Before joining Principal Global Investors, McCaughan was chief executive for the Americas at Credit Suisse, based in New York, and before that, president and chief operating officer of Oppenheimer Capital. He began his career as an actuary at Lane Clark & Peacock, London.
In his time at Principal Global Investors, the firm has made many acquisitions. Recently, it bought majority stakes in Finisterre Capital, a hedge fund that specialises in emerging market debt; Origin Asset Management, a quantitative global manager with a strong presence in emerging markets; and Liongate Capital, a hedge fund of funds that will, says McCaughan, meet a demand for outcome-oriented, absolute return funds.
McCaughan says the firm is considering more acquisitions, though none he can disclose. These could be in real estate. Although the company has a US real estate business and a global real estate investment trust capability, it does not have the capacity to invest in private real estate on a global basis. “A way to get there is an acquisition. We’re looking,” he says.
McCaughan says he may also consider acquiring an infrastructure investment firm, and would like to improve the company’s coverage of frontier market investment.
THE GOLDEN AGE
I want to know if there are any acquisitions that have not turned out well. Has Principal Global Investors had to sell any of its stakes? McCaughan says the one substantial divestiture was of a firm called Beach Point Capital Management, which was the hedge fund business of one of its boutiques, Post Advisory Group. He says the sale came because of “stresses between the long-only and the long-short business”.
“We’ve not sold one because it was troubled. It could happen, though.” He says that, unless there are problems, Principal Global Investors prefers to maintain its ownership stakes at the levels it first bought them. The firm has occasionally increased its stakes, but generally this was only to buy out members of management teams prior to retirement.
As McCaughan looks to the future, and considers how the asset management industry will overcome its “complacent” attitude, is he cautious or confident? It seems he is far from pessimistic. “A few months ago we had a consultant in and he talked about the golden age of asset management, the 80s and 90s. I said now is better than that, because there are more new things happening. Some things we’re talking about, you wouldn’t have thought about ten or 15 years ago. That’s why now is such an interesting time.”
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