Interesting News (March 12, 2013)

Financial Post:
Bigger is not always better | Small investment firms have edge over large ones

March 12, 2013 | Martin Pelletier

A couple of years ago, upon the birth of our second child, my wife and I capitulated and bought a big minivan thinking we were going to need the space. I must admit it was quite the vehicle as the only thing it was missing was an ensuite bathroom.

That said, it also came with excessive gas bills, high maintenance costs and a lot of dent repairs thanks to narrow drive-throughs and tight parking spaces. We eventually decided to downsize to a compact SUV and haven’t looked back. Our maintenance and gas bills have been cut in half and we surprisingly have plenty of space.

The same downsizing philosophy can be applied in the financial world when selecting a firm to manage your investments. Smaller investment firms are like compact SUVs in how they maneuver through tight corners. When markets are volatile, they can react much quicker than larger firms, which typically have to go to an investment committee meeting before making a change.

Some firms are so large that the liquidity of the market creates a challenge, which is why many can outgrow the investment style that made them successful in the first place. Unfortunately, it isn’t uncommon to see these larger firms expand into closet indexers, performing in-line with a passive index.

Smaller firms can also often get you from point A to point B at a lower cost because of their low overhead. For example, some firms have eliminated the relationship manager, and put the person making the actual investment decisions directly in contact with the client.

The portfolio manager gets paid the same in both scenarios, but the cost savings of not having a relationship manager, which at times can be in excess of 1% per year, can be passed on to the client. More importantly, there is greater accountability, because the portfolio managers are directly responsible to clients for their actions.

A common pushback is the claim that larger firms have more resources. But many smaller boutique investment firms receive the same thirdparty research as their larger peers, and have the same access to senior management of the companies being investigated as a potential investment.

Another often made argument is that larger firms are safer. But reputable smaller independent investment firms always use a third-party custodian, so clients’ assets are separately held from the firm managing them.

At the beginning of 2008, Bernie Madoff ’s firm had US$17-billion under management. The reason why his firm propagated its Ponzi scheme for so long was that it self-custodied their clients’ money.

My point is not to criticize those who have successfully built larger investment firms as there are many who still offer top-notch investment services. But you shouldn’t rule out the benefits that the smaller investment boutiques offer.