Boutique Business Model under Attack: Bruised by Regulation, Crippled by Costs?

Boutique asset managers (“boutiques”) have a unique arsenal of advantages. Boutiques are able to embrace entrepreneurialism and act quickly. There are few “middlemen” and little time consuming bureaucracy due to the smaller staff. Despite these advantages, boutiques are being overwhelmed by the combination of an onslaught of regulatory requirements and the institutionalization of the industry – leading to higher hurdles for raising assets and rising cost-to-income ratios.

The most problematic issue facing boutique managers in the next 12 months is the increasing expense of regulatory compliance. It is no surprise that costs are going up as new regulations are implemented and enforcement agencies increase the amount of inspections and requests for information. It is a common mantra among small businesses, and asset managers are no different. Related to the rising regulatory cost, boutiques also face higher cost-to-income ratios. This is usually caused as the firm tries to grow and expenses rise while the firm struggles to raise enough assets to cover the increase.

The biggest barrier to entry for new boutiques is the “institutionalization” of the industry that leads to higher due diligence and compliance costs. This plays into the hands of the proverbial Goliaths who can spread these costs across a more significant revenue base. Scale is the feature that boutiques know they lack, and technology and better operational efficiency are the keys. This may include outsourcing or reevaluating other aspects of the firm’s profitability.

The investment landscape continues to bifurcate between beta and alpha. Behemoth asset managers have the advantage of scale and breadth. Hedge funds continue to attract capital from investors seeking outsized returns. Regulatory requirements are contributing to increased costs, while the investor due diligence process becomes more onerous. The result could be stealth consolidation within the buy side as firms find it cost prohibitive to continue.

Perhaps this is what the regulators intended. Forcing consolidation by increasing compliance costs would certainly make policing the industry more manageable. Regardless of intent, a dearth of boutiques would be a negative for the investor and the industry alike. A high degree of concentration is only likely to exacerbate the issues that cause investors to pause – cross-asset correlations, lack of outperformance and pricey management fees. However, regulators are not concerned about creating high degrees of concentration. It remains an unintended consequence that we all hope to avoid. Fortunately, there is enough that remains within the power of the boutiques to remain optimistic.