Financial servicesFund managers: how big is too big? |
Some say R10bn is too much while others seem comfortable with more than R100bn. Moneyweb investigates.
Fund manager Allan Gray's television advert tells the tale of a boy who pursues a girl in his school. In doing so, he is teased by his classmates and even gets beaten up. His willingness to withstand such abuse becomes apparent when the camera cuts to the girl's beautiful mother.
The message is an appropriate one in the investment world: assets that are unpopular could mature into prize possessions if their owners exercise a little patience and ride out short-term discomfort.
But what if the schoolboy had a limited choice of girls? Imagine if the school had over 350 girls, but the boy's choice was limited to fewer than 35. His chance of investing in a winner would be reduced.
A similar problem faces very large fund managers.
For example, a manager with R100bn that wishes to invest 5% of its assets in a particular company is limited to companies worth at least R20bn. This assumes the manager restricts itself to owning no more than 25% of any particular company - common practice in the industry.
There are fewer than 35 JSE-listed companies that are worth more than R20bn. Yet there are more than 350 listed stocks.
For many fund managers the question of size is a hypothetical one. Few manage to attract the type of money that might be considered cumbersome.
Yet there is a strong incentive to grow assets. Fund managers typically charge their clients a percentage of the money they look after. The larger they become, the more money they make. Therefore the decision to turn away business is not an easy one to take.
One manager that took the plunge is Regarding Capital Management (RE:CM). It closed its local funds to new money at the beginning of 2007. At the time it had about R10bn under management.
RE:CM noted that the growth in its assets under management had the effect of reducing new investment ideas.
Founder Piet Viljoen says RE:CM is in the process of reopening its doors to new investment. This comes after some withdrawals and an increase in investment opportunities on the JSE. Viljoen says RE:CM will first encourage existing clients to invest more money and then welcome new investors.
Viljoen says he's trying to break a cycle in which fund managers tend to take money when share prices are high. "We look for money when assets are cheap," he says.
Viljoen says that it is possible to beat the market with a much larger fund, but that the odds of doing so reduce the larger one gets.
Adrian Saville, founder of Cannon Asset Management, is another fund manager who believes that size and performance are not always compatible.
Saville says a fund manager's capacity depends on the size of the investment universe. If one is managing a global portfolio, where one has a choice of stocks worth about $30trn, "it is hard to imagine any South African manager growing to a size where they would crowd themselves out," he says.
However, this changes in a South African environment where the largest 40 stocks account for about 85% of the entire market's value. Saville says that any manager that looks after more than R50bn is confined to 50 or 60 stocks. Such a manager is going to find it difficult to beat the market, he reckons.
Saville says one of Cannon's key competitive advantages is its ability to have "meaningful exposure" to 250 JSE-listed companies listed. He considers R25bn to be the maximum amount of money that Cannon could handle across all mandates. Saville says Cannon's Equity Fund, which invests in a number of small- and micro-cap companies, could handle up to about R5bn at current market prices.
One potential solution to the size problem is to have multiple funds, each with different styles, and that weight stocks in different proportions. This model is followed by institutions such as Stanlib, Investec Asset Management and Old Mutual Investment Group SA.
For example, Stanlib clients are able to invest in smaller companies through its Small Cap Fund, even though the fund manager is one of the country's largest.
But the trouble with multiple styles is the fact that some are bound to perform much better than others. How will investors know which is going to be best? And if an analyst comes up with a good idea, which fund will have first choice?
Allan Gray, one of the country's largest fund managers with over R200bn under management, does not believe in a multi-style approach. It applies the same investment recipe for all money invested in local shares, which totals roughly R140bn. Thus, it is impossible for a small company to have a meaningful contribution to its clients' performance.
To give an indication of Allan Gray's size, consider that its clients own a quarter of Harmony Gold (JSE:HAR). Despite being a large company, Harmony comprised only 5% of clients' share portfolio at the end of last quarter. There are fewer than 30 JSE-listed stocks that are worth more than Harmony.
If Allan Gray wishes a particular company to comprise 10% of its clients' share portfolio, it has a choice of less than 15 JSE-listed stocks.
Allan Gray insists that its size will not prevent it from beating the market in years to come. Retail director Johan de Lange has previously told Moneyweb that the bulk of Allan Gray' past outperformance has been the result of stakes in large companies.
De Lange notes that a company's weighting also changes with its share price. For example, Harmony weighting has been higher than 6% and lower than 4% due to price movements.
De Lange also says that Allan Gray's contrarian investment style makes it easier to buy and sell big stakes in companies. "We tend to buy and sell at different times to the market in general," he says. "This gives us additional liquidity."
Allan Gray measures its size in terms of what portion of the JSE's free float market value its clients hold. Free float refers to shares available for investment: in other words those that aren't held by company directors or holding companies. De Lange says that Allan Gray's share of the JSE's free float has actually declined over the past three years even though assets under management increased substantially.
Nevertheless, the asset manager is mindful that there is a point at which it will become too big.
The fund manager recently chose to save its spare investment "capacity" for more lucrative business. Allan Gray reduced its wholesale discount, which resulted in its products being dropped from the platforms of certain linked investment service providers (Lisps) (see Lisps drop Allan Gray - November 2007.) Its capacity was thus spared for the more lucrative retail market.
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