When a brutal recession knocks an industry’s profit model on its head and sparks a wave of consolidation, bigger, in the end, usually means better.
Or not. A study released in August by Northern Trust Co. using data from Web-based data collector eVestment Alliance in Marietta, Georgia, suggests that institutional investors might do better with small managers. “Size is the enemy of performance,” says James Dunn, the newly appointed chief investment officer of the $1.2 billion Wake Forest University endowment in Winston-Salem, North Carolina. “If you’re a battleship, you can’t move fast enough.”
The top 30 investment firms globally currently control 75 percent of all institutional assets, the survey found. Small firms, with assets of $2.6 billion or less, lost 0.74 percent per year over the five years ended December 31, 2008, compared with a 1.23 percent annual drop for large firms, with $100 billion or more, over the same time period — with less volatility. The median small manager outperformed the median large firm by 0.41 percent annually in the survey, translating into cumulative savings of more than $4 million on a typical $200 million institutional allocation.
Also, one third of the managers in the top quartile had less than $2.6 billion each in assets. “Smaller firms tend to be more entrepreneurial and nonbureaucratic,” says Ted Krum, vice president of portfolio management at Northern Trust Global Advisors, the emerging-managers unit that oversees $29 billion and commissioned the survey.
The findings come as investors assess their portfolios in the wake of last year’s market crash. Experts predict a record number of hirings and firings through 2009 and 2010, as large investors ditch managers that underperformed. They also expect a wave of M&A. Janice Fritz-Snyder, head of North American research for Watson Wyatt Worldwide in Stamford, Connecticut, says there’s a downside to consolidation: Big firms aren’t as nimble, and investors may pay the price. “Can you be an invisible investor and be able to get out of a bad situation quickly without others knowing you’re a seller or get into a good situation cheaply without pushing up the price of a stock?” Also, as managers grow, they have to pick new stocks to accommodate ballooning assets — and these ideas might not be their best, says Erik Ogard, head of client strategies at Russell Investments, a Tacoma, Washington–based consulting firm: “If you get large it can be a headwind, and if you stay small it can be a tailwind.”
