December-January 2017

SWISS EQUITIES: Defending the little guys

Switzerland’s boutique asset managers face a range of pressures. To survive, they must adapt to a highly regulated world where passive funds threaten their market share. George Mitton reports.

On a warm September day, the sun glints off the placid waters of Lake Geneva. It is a peaceful scene, but don’t be misled. Switzerland is a country that still has compulsory military service for men and which requires soldiers to keep their weapons at home. Though the prosperous shoppers crossing the Mont Blanc Bridge today are unlikely to erupt into warfare, the Swiss want you to know that, should the need arise, they will withdraw to their mountain hideouts, reach for their rifles and protect themselves.

The Swiss people are not currently under attack, but the same cannot be said of the country’s boutique asset managers. A number of forces assail these small, specialist firms. For them, this is a time to think about defence – of market share, brand and even their raison d’être. But how can this be done?

CHALLENGES
One of the difficulties facing Swiss firms is that assets have fluctuated this year, tending to fall as often as they have risen. In October, the Swiss asset management industry had 903 billion Swiss francs (€840 billion) under management, a decline of 1% compared with the previous month, according to the Swiss Funds & Asset Management Association.

Markus Fuchs, managing director of the association, said the fall was due to market losses in September, which sapped investors’ appetites for fund investing. “Added to this, there were net withdrawals from nearly every fund category [in October], with bond funds hardest hit,” he says.

It is possible to weather these periods of outflows if you are a large manager such as UBS, which has more than a quarter of the Swiss funds market by assets, or Credit Suisse, with a 16% share. These giants have broad fund ranges that span asset classes, and their large teams benefit from efficiencies of scale.

For boutiques it can be harder, and not only because of redemptions. Across Europe, regulation is becoming more onerous, and regulatory costs tend to hit small firms disproportionately hard. In relative terms, it costs a firm of 30 more to hire a new compliance manager than it costs a firm of 30,000.

Then there is the big challenger: passive investment. Boutique firms rarely specialise in passive products such as exchange-traded funds (ETFs), which are generally the preserve of big firms such as BlackRock or Vanguard. Instead, boutiques tend to offer a handful of actively managed funds, usually with relatively high fees.

The problem is that actively managed funds face acute scrutiny these days. Numerous researchers have found their performance to be inferior to passive funds, once fees are included.

The situation is so dire that one of the UK’s regulators, the Financial Conduct Authority, published a damning report in November that suggested active asset managers were failing their customers.

BARRICADES
How can small fund companies survive these threats? One tactic is to identify those few fund types that are getting inflows, and focus on them. For SYZ Asset Management, a Geneva-based firm with 16 billion Swiss francs under management, multi-asset funds are promising.

“This year has been a tough year for the asset management industry in terms of outflows from risky assets,” says Katia Coudray, chief executive. “The only positive flows at the industry level are to multi-asset funds.”

The firm has recruited new employees for its multi-asset team and launched two new funds, believing there is a demand for products that actively allocate between asset classes.

Alongside product launches, the boutiques are fighting back against criticism of active management. Coudray denies that passive funds are a good substitute for active ones, and claims her firm’s funds are capable of generating “true alpha”.

“The market has been supportive for passive strategies since 2008,” she says. “For the future I think it will be different.”

Unigestion, another Geneva-based manager, is also investing in its multi-asset capability as a means of securing flows in a difficult environment. Fiona Frick, chief executive, says it is important to know one’s specialism and concentrate on it.

“We cannot compete with the passive robo-advisers but we can compete on the outcome-oriented, active product type,” she says.

Perhaps the key to survival for boutique managers is to make a case that small is beautiful. Because of its modest size, Unigestion, which manages about $21 billion (€20 billion), can be nimble. The firm, which gets about 95% of its assets from institutional investors, has co-created a number of investment products in partnership with clients. Larger asset managers might have found it harder to be so flexible.

“We define ourselves as a boutique because we have the mindset of one,” she says. “We tailor to the client to make sure the costume fits.”

FUTURE
Despite this optimism, some unique challenges face Switzerland’s boutiques. One is the strong franc.

Some history is instructive: In 2007, a euro was worth about 60 Swiss cents. That figure, which was comfortable for Switzerland’s many export industries, rose steadily after the financial crisis as investors around the world bought the Swiss franc as a hedge against other currencies.

The strengthening currency threatened to make Swiss exports uncompetitive, so in 2011 the Swiss central bank capped the exchange rate with the euro, ushering in three-and-a-half years of relative stability, in which it cost about 82 Swiss cents to buy a euro.

Unfortunately, the asset purchases needed to maintain the cap were risky and on January 15, 2014, the Swiss National Bank decided to abandon the peg. The franc surged against the euro and has stayed strong ever since, so that, today, the currencies are not far from parity, with a euro costing roughly 93 Swiss cents.

The strong currency has hurt exporters and pressed down returns for franc-based investors. “We hoped it was temporary,” says Coudray of the currency’s strength, “but it’s lasted for two years now. It’s challenging.”

Another difficulty for boutiques is that, despite their insistence that active management is valuable, data continues to emerge that suggests stock-pickers are failing to match their benchmarks.

Index provider S&P recently showed that more than half of euro-denominated, actively managed European equity funds failed to beat their benchmark in the first half of 2016. Over five years, the situation is worse, with nearly 80% of funds failing to beat their benchmark.

The final pressure is internal. In order to develop new strategies such as multi-asset funds, boutique managers have to take on more staff. That means more costs. Yet boutiques cannot realise economies of scale unless they become a great deal larger, which they do not want to do.

It is a contradiction: on the one hand, it pays to stay small; on the other hand, a larger organisation is needed to handle complex tasks such as multi-asset investment. And, just like big firms, boutique managers must meet the stringent requirements of legislation such as the Markets in Financial Instruments Directive, which requires employing compliance and legal teams.

Despite these challenges, many Swiss boutique firms maintain an optimistic view. Some have offices within the eurozone and hold euro, dollar or sterling assets, insulating them, to an extent, from the effects of the strong franc. Others have strong relationships with loyal clients and are confident their mandates will not be cancelled in favour of ETFs.

The Swiss know about defence. The country’s boutique asset managers must put this wisdom into practice.

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