Lack of FX volatility has led to boutique premium in obscure asset classes

FX volatility has been at a low for many years, which, combined with the increase in copetition which has taken a large share of lucrative deal-contingent hedge revenues, has led to FX dealers looking closely at mid-cap and emerging market transactions.

Research by Cass Business School Asset Management in London, released today, shows there to be a ’boutique premium’ in the European fund management industry of 0.56% and 0.23% net of fees, depending on which methodology is used.

The outperformance was particularly pronounced within the European small- and mid-cap and global emerging markets fund sectors, with a net-of-fees boutique premium of 1% and 0.5% respectively.

The hedges give purchasers protection against FX movements between the announcement of an M&A deal and its completion. Increased competition in this space has seen the price of the hedges slide from 25% of the cost of an equivalent option in 2015 down to as low as 15%.

The boutique premium was first coined by asset manager AMG Group in 2015 when it reviewed the performance of US boutiques versus US non-boutique asset managers, the company actively promoting itself since then as the ‘partner of choice to the world’s leading Alpha-Generaring boutique firms”.

Going back a few years, Drew Niv, at the time CEO of FXCM which was one of the world’s largest retail FX companies with its own proprietary infrastructure, publicly stated that 2013 was the period in which FX volatility had been the lowest for two decades.

Since then, volatility – with the exception of the black swan event caused by the Swiss National Bank’s removal of the EURCHF peg – has been very low indeed.

Some may view it as perhaps somewhat ironic that the CEO of a company that specifically sought to consider spot FX market making as its core business activity and eschew multi-asset trading or exchange listed derivatives despite its retail market dominance and the flexibility of its own infrastructure to state lack of spot FX volatility as a major issue, however it was a correct analysis that has since continued.

Professor Andrew Clare, who undertook the research at Cass Business School Asset Management, which is thought to be the first research of its kind, said the results “provide enough evidence to warrant further analysis of this important part of the asset management industry”.

“Future research should focus on the factors behind the existence of the boutique premium, such as the ownership structure of boutique managers and/or their approach to portfolio construction,” Professor Clare said.

Tim Warrington, chairman of the Group of Boutique Asset Managers (GBAM), who Clare consulted with to identify boutique firms, said the results were unsurprising as boutiques were “smaller, highly motivated, specialist firms which seek to consistently outperform while aligning their interests with that of their clients”.

If this is not another trigger for the retail firms to elevate their product range toward the asset management and multi-asset sector, then who knows what is.

There are a series of companies that will assist with this now, including INVAST Global which provides access to a highly diverse range of assets and has gone the hedge fund route from a prime of prime brokerage perspective, oneZero, which has been concentrating on hosting and can connect brokerages to venues globally on an SaaS basis, and Markets Direct, which integrates exchange listed derivatives into the same MetaTrader platform as OTC derivatives, meaning they can all be traded in one platform.

Mr Warrington “Given the compounding of this premium over time could produce significant additional returns to investors, far more needs to be done by advisers and fund platforms to expose these benefits to long-term investors.”

Indeed so, and a move in this direction would tap into a lucrative market, as well as steer retail firms away from the ‘race to the bottom’ loss-sharing model that has attracted the wrong sort of attention from the regulators over recent years.

Professor Clare’s research looked at 120 large fund groups and identified 780 long-only funds across all equity sectors, tracking their performance between January 2000 and July 2019.

It compared those results with boutiques as defined by GBAM and three investment consultancies that advise institutional pension schemes and insurance companies.

The methodologies used were the Fama/French five factor, and an index model to risk-adjust returns collected from Morningstar.

The ability to participate in this sector has been gaining momentum, and should be paid attention to.

Just over a year ago, four new very large investment trusts poured into the British market, commencing from a very high capital base, which is something rarely achieved by OTC brokerages who have to often bootstrap their businesses and rely on outsourced third party infrastructure.

The four new funds were launched by well recognized major asset managers and were designed to head onto the market in the form of new investment trusts, between them raising upwards of £1 billion from investors at the outset. Shares in the funds are now trading on the London Stock Exchange and the aim was to make money for long-term investors – and, of course, the managers themselves.

Fellow city stalwart Mark Mobius, one of the architects of Britain’s very first emerging markets trust in 1989 which he managed until 2015, also launched a new fund.

The new trust had ambitious targets from its outset– annual long-term returns of between 12 and 15 per cent from a portfolio of between 20 and 30 emerging market companies. While some may say Mobius is a bit long in the tooth at 83 years of age, he has brought two emerging markets specialists with him from asset manager Franklin Templeton (where he was when launching said emerging marekts trust 29 years ago) – Carlos Hardenberg and Grzegorz Konieczny.

For Joe Bauernfreund, the Far East holds his opportunity, as his firm, Asset Value Investors (AVI) looks to raise £100million for this trust that will invest in a tight portfolio of Japanese companies.

Although Asset is not a household name, it manages an established investment trust – the £1 billion global British Empire. This has outperformed peers over the past four years – a return of 76 per cent against 69 per cent for the average global growth trust – but underperformed over five.

The trust’s annual management charge is one per cent and the launch’s closing date is October 18 with share dealings commencing five days later. The trust is likely to pay a dividend although there is no commitment to dividend growth.

Brian Dennehy, director of investment fund scrutineer FundExpert, believed at the time of launch that Japanese smaller companies offer investors the potential for attractive long term returns. Many companies, he says, are ‘undervalued and under-researched’. But rather than take a gamble on a new trust, he suggests investors should look at established funds. These include Baillie Gifford Japanese Smaller Companies and M&G Japan Smaller Companies.

Lastly, Merian Chyrisalis launched a new fund in 2018 managed by Richard Watts and Nick Williamson, which is operated by Merian Global Investors – Old Mutual Global Investors as was – and invests in UK unquoted companies. It was intended to try to to make money as the businesses it buys move from private ownership through to a listing on the UK stock market.

The managers, Richard Watts and Nick Williamson, are established investors in small and medium-sized listed UK companies.

For example, over the five years ending September 2018, Watts  delivered a 103 per cent return at the helm of fund Old Mutual UK Mid Cap – a performance only beaten by three funds in its UK all companies peer group.

Investing in unquoted companies is not their speciality, but the duo insist they are tooled up to spot businesses that will successfully make the transition from private to shareholder ownership. Merian Global Investors is led by respected investment manager Richard Buxton.

It is perhaps a missed opportunity that many retail brokerages see that sector as external, because equities, stocks and futures on a managed basis suit the functionality of most modern trading platforms – including MetaTrader – very well indeed and attract a far higher value and longer lasting customer base.

The ability for these fund managers to pull in talent from the top Tier 1 banks on the launch of these funds and attract vast venture capital funding as well as investor input totaling tens of million from the outset as a new, unproven managed fund, shows the total confidence in that sector, whereas no OTC firm is able to do that from the outset.

Companies with proprietary platforms do indeed envisage this as important, IG Group has its own retail stockbroking platform, and Saxo Bank and Swissquote both concentrate very heavily on multi-asset trading environments.

During a recent meeting at Swissquote’s head office in Gland, Switzerland, FinanceFeeds looked closely at this.

Expanding on the execution methodology, Jurg Schwab, Head of Trading, Director and member of the senior management at Swissquote explained “Swissquote is a direct member of Euroclear, and it is very rare in the electronic trading industry to have direct access to stocks. We also have a dedicated bond platform, which executes on an OTC basis. All trades are cleared onsite” he said.

“Switzerland is one of the few countries where bonds are listed on exchange, however for global markets we do it on an OTC basis, whereas we are a full member of Eurex for trading and clearing, this being a USP in Switzerland” Jurg Schwab, Director and Head of Trading, Swissquote Bank SA

“We specialize in providing online direct access for customers, therefore we do not differentiate between trading option on US stocks such as Apple or on Swiss stock and the trading experience should be equally accurate for both, as the margin is all calculated in a fraction of a second” he said.

“We also have a well recognized OTC platform called SwissDOTS. The name is derived from a contraction of “Derivative OTC System”. We currently work with five partners which offer over 80,000 leveraged products. Comparing this to all products traded on SIX, there are around 25,000, hence SwissDOTS users can access three times more products than SIX, and the opening hours are from 8.00 am till 10.00 pm, so therefore traders wishing to trade after the hours that other venue may close trading for the day can continue to trade derivatives on SwissDOTS”Jurg Schwab, Director and Head of Trading, Swissquote Bank SA

“EUREX is the biggest one, where we provide US on-market products, and then we provide warrants on SIX, then SwissDOTS OTC, followed in size by the London live market and the Asian market. I put every thing together because we have less volumes on the others than on some, however derivatives are a mainstay of the business” he explained.

“During the founding of Swissquote, listed derivatives were the backbone of the company. The warrants that we provide are mostly indexes, equity, bonds, commodities and realestate but the main underlyings behind the warrants are indices and equities, with a global customer base. The majority of the customers for listed products are in Switzerland, we dont actively seek overseas firms but we do have 300,000 customers globally in trading” said Mr Schwab.

“Everyone has access to all the products on one single platform, incuding our entire securities business, and credit facilities but also traditional FX. For leveraged OTC margin FX, we also provide our own proprietary Advanced Trader FX platform, or MT4 and MT5” he said.

Saxo Bank has also branched in that direction, having built relationships across the Asia Pacific region with hedge fund operators, as reported in detail by FinanceFeeds during a private event in Hong Kong.

Hargreaves Lansdown, Britain’s largest financial services company whose CFD division, HL Markets, is a white label solution provided by IG Group, is a firm with its own multi-asset investment platform, Vantage which has been demonstrated to FinanceFeeds during a visit to the firm’s Bristol head office.

This is certainly a way forward for FX brokerages, and the premiums, cost savings and chance to access high quality and discerning client basis are really too good to miss.