Boutique firms have to concentrate more extensively on managing themselves, not merely on managing money, according to a study of small- and midsized firms.
Firms with less than $5 billion under management are confronting issues including planning for the founders' succession, a slowdown of asset growth and structural concerns that affect the ability to generate new accounts, according to a new survey by Investment Counseling Inc., West Conshohocken, Pa. The survey tries to address the "growing pains" of those firms, which average 16 years in business, said Chas Burkhart, president of Investment Counseling.
These small, entrepreneurial firms began as small shops led by star portfolio managers and are now large enough to have to deal with staffing and marketing issues, said Mr. Burkhart. Many now begin to realize the need for separate marketing and public relations functions, additional product offerings and staff, and they need to find ways to implement those solutions, he said.
Small and midsized firms with an institutional, tax-exempt orientation have shown noticeable growth, posting an annual compound rate of asset growth of 41% during the last two years, but asset growth in institutional accounts is slowing from an average of 75% annually in 1991-'92 to 53% in 1992-'93. The study warns that the institutionally oriented firms are losing ground to multiproduct providers, and single-product boutiques won't be able to maintain high levels of performance and new account generation.
Smaller firms are more at risk than larger ones because of their often limited relationships and concentration of assets and clients, said Mr. Burkhart. The loss of a couple of clients can mean the loss of a large portion of their revenue base, he said. That does not mean the firms will fail, but they must manage growth more effectively, said Mr. Burkhart.
Smaller firms have trouble adding assets because sponsors don't want to be more than 15% to 25% of the total asset base, while the managers don't want to take on portfolios too small to be profitable, says the study. They also have staffing problems because as they grow, the investment team gets called out of their office more often for client meetings, according to the study, which suggests firms need to differentiate between portfolio management, client service and marketing functions.
To compete, small firms can try to be the best managers of a limited product or offer a much bigger product selection, basically hedging themselves against changes in investment strategy among their clients, said Mr. Burkhart. Building requires large expenditures on systems and people, however, he said. Some firms respond by spinning off new products from old ones, such as a midcap product spun off from a small-cap product, although that may not provide enough product differentiation.
The small firms need to understand the compensation and marketing issues they face and where they stand in the market to make the appropriate decisions, said Mr. Burkhart. There is a need for peer benchmarking and understanding what are reasonable profit margins and what expenses affect those margins in a growing business, he said.
According to the survey's findings the firms are not spending money on those items designed to increase assets. Compensation - salaries and bonuses for principals and non-principals - is their largest expense, accounting for 58.4% of total expenses on average. Systems and operational expenses were only 3.1% and advertising and marketing made up only 1.9%.
However, all expenses are increasing at double-digit rates, with salaries for both principals and non-principal staff increasing by 23% in 1992-'93 and bonuses increasing at twice that rate. The expense increases suggest the companies are still building their infrastructure, according to the study.
The largest increase was in conference and seminar fees, up 103%, showing that outside education and marketing are becoming highly valued. That result may be an anomaly, caused by a few firms spending large amounts, said Mr. Burkhart, but he noted that marketing expenditures are also up by 28% on average.
The issue of succession is another key question facing independent firms, many of which have principals near or already in middle age, according to the study.
"You have the whole aging of the independent culture," said Mr. Burkhart. According to the survey, 62% of firms are seeking ways to prepare for the founder's absence by bringing younger staffers up the seniority ladder and giving them more client contact responsibility. However, 38% of the firms have not even considered the issue of who will take over, which puts them in a risky position, said Mr. Burkhart.
According to the survey, the majority of buy/sell agreements are in place to protect the firm in the event of the owner's death, but few believe in selling until it is absolutely necessary. Nearly one-fourth of the firms are still 100% owned by their founders, and the average key-man ownership in the group is 72%. Roughly half the firms surveyed said they had people in place to whom the founders would transfer ownership, but the other half had not made any arrangements, and less than 20% plan to sell the firm to current employees.
Ideally, firms should start planning for succession five to 10 years before the issue comes up, said Mr. Burkhart.
The study, Managing an Investment Counseling Firm, surveyed 40 firms with $5 billion or less in assets under management.