Equity boutiques most vulnerable in market downturn

Boutique equity managers are proving to be the industry segment most vulnerable to the market implosion of the past 18 months, and a number of those firms will struggle to remain independent this year, according to a recent report by Greenwich Associates.

On May 1, one boutique well known to institutional investors lost that struggle.

Old Mutual Asset Management, a holding company with 17 boutique money management subsidiaries, decided to wind down Clay Finlay LLC, an international equity boutique whose assets under management had slumped to $1.8 billion as of March 31, from $5.4 billion at the end of 2007.

Thomas M. Turpin, OMAM’s president and CEO, praised the job that consulting industry veteran Rosalind M. Hewsenian had done since coming in as CEO in November 2007, but said market conditions and the economic environment made closing the firm over the coming months the best option. Client defections had aggravated the plunge in market valuations, with net outflows of $263 million in the first quarter following outflows of $480 million in 2008 and $1.5 billion in 2007.

The Greenwich report — based on a survey of 61 money management firms in December and January — suggested a number of other boutiques could be facing a similar squeeze.

The survey showed operating margins for the group tumbling to 24% in late 2008 from 33% at the end of 2007, with cost cutting and headcount reductions expected to limit further prospective declines to 21% for the current year. However, six respondents — mostly boutique equity managers — told Greenwich they expect no operating profits this year. The report predicted that firms such as those “will need to be acquired or recapitalized in order to survive.”

The Greenwich survey showed firms with less than $10 billion in assets under management anticipating a plunge in operating profit margins between 2007 and 2009 of more than 50 percentage points — roughly double the decline anticipated by firms with $10 billion to $25 billion and those with $25 billion to $100 billion. By asset class, equity-focused firms predicted a roughly 45-point decline, compared with 33 points for “diversified” firms and 13 points for fixed-income-focused firms.

While conceding the likelihood of casualties, some market veterans said they anticipate a culling, rather than a slaughter. With relatively low fixed costs, many small- and midsize equity managers have more latitude to adjust to a down market than their bigger cousins, said David D. Silvera, a managing director with Rosemont Investment Partners LLC. The West Conshohocken, Pa.-based private equity firm counts a number of equity boutiques among its investment portfolio.

For every firm tottering now under the weight of the market’s collapse, there will be at least two that manage to survive and thrive, Mr. Silvera predicted.

In a telephone interview, Stamford, Conn.-based Greenwich consultant Chris McNickle said equity boutiques, defined as firms with less than $10 billion in assets, that were growing fast enough in the run-up to the market’s collapse to invest heavily in staff, infrastructure and new strategies will prove especially vulnerable, as will midsize firms that were laying the groundwork for expansion.

Firms that had started to work toward a certain level of growth before equity valuations fell off a cliff last September could find themselves in dire straits, especially if they were struggling performance-wise as well, agreed David Bauer, a partner with Darien, Conn.-based money manager consultant Casey Quirk & Associates LLC.

Conversely, boutiques that are lean and mean and beating their benchmarks report that they haven’t been derailed by the market’s travails.

For example, Michael A. Cavarretta, president of Boston-based Frontier Capital Management Co.LLC, said his firm’s assets under management slipped less than 10% in the brutal fourth quarter to $4.4 billion, cushioned by $1 billion in net inflows. Roughly three-quarters of those inflows came from a subadvisory mandate from Vanguard Group Inc. for Frontier’s midcap growth equity strategy, which has handily beaten its benchmark for the one-, three- and five-year periods through March 31.

“We’re not a marketing-driven firm,” Mr. Cavarretta explained, noting that Frontier’s recent hiring of a sales executive had doubled the firm’s marketing team.

However, boutiques with underperformance heading into the market’s collapse could find themselves facing a “double whammy,” Mr. Bauer said. For firms that had $5 billion to $10 billion in client assets but now find themselves with $2 billion or $3 billion, or less, net client outflows on top of market declines can amount to a considerable one-two punch, he said.

As 2009 began, one well-known institutional name suffering from outflows was retired when Rittenhouse Asset Management Inc., a subsidiary of Nuveen Investments LLC, was merged into another affiliate, Santa Barbara Asset Management LLC.

Nuveen spokeswoman Kathleen Cardoza said new portfolio management leadership had helped Rittenhouse revive the performance of its growth equity strategy from 2005, but amid continued outflows, the firm's assets under management dropped to $1.3 billion as of Dec. 31, from just more than $6 billion at the end of 2005. Nuveen saw the market dislocation of 2008 as “a unique opportunity to combine these two complementary growth (equity firms) into one larger, more diverse and strong firm,” she said.

Other equity boutiques suffering through stubborn bouts of underperformance when markets fell include well-known institutional investment names, such as Ariel Investments LLC, a Chicago-based value equity boutique, and Mazama Capital Management Inc., a Portland, Ore.-based growth equity shop.

According to performance tracker eVestmentAlliance LLC, Ariel saw net outflows of $1.4 billion in 2008, with assets under management plunging 67% in the calendar year to $4.4 billion. Despite a rebound in first quarter performance, Ariel's AUM tumbled another 24% to $3.3 billion as of March 31.

While it didn’t provide net flow data for Mazama, eVestmentAlliance reported the firm’s AUM as of March 31 at $1.02 billion, down from $6.84 billion as of year-end 2007.

In an interview, Mellody Hobson, Ariel’s president, conceded that 2008 was the worst year in her memory but said her firm was more than prepared to cope. Ariel, she said, had built up a war chest for a “rainy day” by retaining “30% of our earnings every year.”

And while the rainy day, when it came, turned out to be a flood, Ariel had accumulated “tens of millions of dollars” to support the firm’s operations, Ms. Hobson said. Much remains uncertain about the economic outlook, but “our people know exactly what they will make this year,” she added.

Mazama officials told a similar story. “Many firms do pay out 100% (of their earnings) each year, but that has never been our model,” said Brian P. Alfrey, executive vice president and chief operating officer at the firm. “We have retained earnings within the firm to weather downturns,” leaving the firm free at a time like this to “focus on growing our business,” he said.