Bigger is not Always Better
Q3 | November 2018
November 7, 2018
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Bigger is not Always Better
Q3 | November 2018
“The asset management sector in Canada is in a consolidation phase with privately held firms being snapped up amid heightened competition.” (1)
The acquisition of independent investment management firms by banks is a trend evidenced by this year’s purchases of Jarislowsky Fraser and MD Management by Scotiabank, and more recently, Greystone by TD.
The concentration of assets in the largest-of-the-large firms is making “boutique” firms like Nexus members of a very exclusive club. Many of the marquee names in the business started out as private wealth managers. However, in order to increase assets under management and revenue, they branched out to take on institutional investors, made acquisitions of their own, or were acquired.
But just because they have buckets of assets or manage sophisticated pension funds, does it mean they are in the best position to manage a private client portfolio? We would argue not, and we are not alone in this opinion.
Aside from obvious tax and personal financial counselling expertise that Nexus offers, there are other reasons why a client should prefer a smaller firm that caters to private individuals. Studies conducted on this topic by firms such as Northern Trust, Alberta Investment Management and Ontario Municipal Employee Retirement System (OMERS) all come to the same conclusion: there are definite advantages that come from having a “small” firm manage your money. (2) (Nexus has $1.9 billion in assets under management.)
Northern Trust began analyzing this phenomenon in 1995, and has followed with more recent updates. Their findings were that small firms enjoy a consistent advantage over industry leaders in a multitude of areas. Some of the specific conclusions are below.
“Clients searching for superior performance potential and defensive characteristics are more likely to find them in smaller firms.” (3)
Institutional investors evaluate performance over shorter-term cycles – typically 3-5 years – and always relative to a market benchmark. This short-sightedness can lead to managers misdirecting their focus and taking undue risk. Nexus has a long-term, absolute return focus, which is aligned with our clients’ interests. Nexus’s philosophy is founded on quality: selecting investments that have both growth potential in good times and defensive characteristics for times when markets are not favourable. These quality attributes include low leverage and cyclicality, profit margin stability and the ability and willingness to pay dividends.
“Small firms outperformed the elephantine household names at the median, as well as top and bottom quartile levels.” (3)
In the latest Institutional Performance Report from Global Manager Research©, the Nexus Balanced Fund was top quartile in every period shown in the table below. The Fund’s ranking is significant, as it is representative of a typical Nexus balanced client, and its composition is comparable to the peer group benchmark.
“Small firms delivered dramatically better performance in down markets.” (3)
Nexus’s clients typically share one common attribute – the need for capital preservation. Our business, philosophy and process have been built around creating portfolios with downside protection.
It is one thing to say as much, and another to prove it. One of the most common measures of capital preservation is an analysis often referred to as up/down market capture. The chart below shows that since 2000 (when our current portfolio managers started working as a team) in periods when its benchmark was up, the Nexus Balanced Fund, on average, was up the same amount. However, when the benchmark was down, the Fund, on average, was down only 56% of the decline of the benchmark. This shows that Nexus’s Balanced Fund, as a proxy for a typical balanced client, has exhibited superior downside capital preservation over the long term.
“Investors who insist on only hiring large firms probably are not protecting themselves, and possibly are missing out on most of the best talent in the marketplace.” (3)
Members of Nexus’s investment team have worked at some of the world’s most reputable companies – JPMorgan, Credit Suisse, McKinsey & Co. and Rothschilds – to name just a few. Alma maters include Harvard, Princeton, Wharton, Yale, Columbia, McGill and Queen’s. Teams of this calibre are rare and fewer are directly accessible to individual clients.
Nexus offers a variety of ways clients can access the investment team: through face-to-face meetings, quarterly investment review luncheons and our annual client presentations. Our managers pick up their own phones and are happy to answer client questions as they arise.
“We hear over and over again that institutional clients hire the largest firms because they view them as safer than emerging firms. In reality, this is just another over-crowded trade that may expose clients to excess volatility and nasty surprises, without adequate compensation in terms of full-cycle performance.” (4)
We believe that large firms are no “safer” than Nexus. We use a third party custodian that holds our clients’ assets and we have been in business for 30 years. There is something to be said about the focus of a small group of people – undistracted by sales or revenue quotas or arbitrary performance targets – concentrating solely on prudently choosing investments; a compliance and operations department that is not overwhelmed with millions of accounts; and client service team members who know their clients on a personal level and are more likely to detect if something is amiss.
“The most obvious ways for large firms to grow have been to create new products or undertake mergers and acquisitions with mid-size firms. Unfortunately, these initiatives… are very costly, distract management attention away from client portfolios, and frequently lead to staff turnover or other unwelcome organizational changes.” (3)
It is not hard to determine who is benefiting from large firms’ proliferation of products. At Nexus, we do not believe investors need a plethora of investment product choice. We have written previously about this in our In Search of Simplicity blog, illustrating how straight-forward investment solutions can outperform complex ones.
“There’s something to be said about viscerally understanding the risk profile of a fund when you have invested in it” (5)
Research from Morningstar concludes that there is a “strong link” between manager investment in a fund and a fund’s performance (6). Managers investing alongside clients aligns the interests of both, and is a powerful signal that the portfolio managers have a strong conviction in their investment decision-making. Nexus portfolio managers and other professionals invest significantly alongside our clients in our pooled funds or in segregated portfolios managed the same way. We are long-term shareholders, not just employees, and in this sense we “eat our own cooking”.
Short term attention on markets and performance means that institutional clients change the focus and behaviour of their investment managers. Given our long-term oriented client base, Nexus does not have to contend with these distractions.
Dedication to clients, better performance (particularly in down markets), less bureaucracy, crisper decision-making, more motivation and less complacency are all factors quoted in the research, and Nexus categorically checks all of those boxes. The result is that we have more time to spend on selecting the best long-term investments and ensuring our clients are being attended to properly.
(1) Armina Ligaya, “TD Bank becomes Canada’s biggest money manager with $792-million deal to buy Greystone Managed Investments”, Financial Post, July 10, 2018.
(2) Northern Trust defines “small” and “emerging” managers generally as those who have less than USD$2 billion in assets under management.
(3) ”Potential Benefits of Investing with Emerging Managers: Can Elephants Dance?” Journal of Investing (Spring 2007).
(4) “Emerging managers hold their edge versus elephants”, Northern Trust white paper, 2009.
(5) Jon Lukomnik, executive director of the Investor Responsibility Research Center Institute.
(6) “Why You Should Invest With Managers Who Eat Their Own Cooking”, Russel Kinnel, Morningstar, March 31, 2015.
(a) Each quarter since January 1, 2000 to September 30,2018 is defined as an “up” or “down” quarter based on whether the benchmark return for the quarter was positive or negative. For up (down) quarters, the capture ratio is the ratio of compound average rates of return for the Fund and its benchmark for such quarters.
(b) Nexus returns are presented prior to the deduction of investment management fees. Past performance is not indicative of future results.
(c) Balanced Fund benchmark is 5% FTSE TMX 91 Day TBill Index, 30% FTSE TMX Universe Bond Index, 40% TSX, and 25% S&P 500 (in C$); rebalanced monthly.