Prior to Henderson Rowe’s investor education campaign, many UK private clients were unfamiliar with the term “institutional-quality solution”. These investors reasonably assumed the same strategies were available to both them and institutions on comparable terms. Unfortunately, they were wrong.
The truth is that large institutional investors – such as pensions, foundations, and sovereign wealth funds – have access to investment strategies and managers that outperform their retail counterparts.(1) But this doesn’t have to be the case. In this article, I discuss the source of this institutional-retail gap and how Henderson Rowe is trying to bridge it.
Understanding Institutional Investors Vs. Retail Investors
With the exception of the wealthiest family offices, most institutions have more money, knowledge, experience, time and resources than even the most educated and well-informed retail investors. This allows them to conduct extensive due diligence before selecting an investment strategy and manager.
Over a period of months (or sometimes even years), institutional investors assess how a strategy works, the environments in which it performs best, the way it is implemented, associated risks, and how those risks are managed. They conduct interviews with the manager’s key personnel, require multiple rounds of written questionnaires, and speak with third-party references. They also review the manager’s track record, operational controls and governance.
Most institutions – unlike retail investors – are not impressed by glossy brochures, short-term performance or black-box products. They are not tricked by gimmicks like “custom” benchmarks that inflate performance, fees masquerading as investment product costs, or outsourced third-party investments and research. In the institutional world, investors have the leverage to demand total transparency, and they have the knowledge and experience to make informed assessments based on objective data.
Investment managers who cannot withstand this level of sustained scrutiny do not raise assets from institutions; instead, they target the retail market. As a result, the strategies and managers employed by institutions tend to be superior, on the whole, to those available to retail clients.
The strategies used by institutions can vary widely, but they tend to share a few common characteristics. As a general rule, institutional strategies:
(i) are evidence-based (by contrast, many retail strategies and products are “black box”, meaning the manager will not disclose the specific details underlying the strategy’s operations or how investment decisions are made);
(ii) have an industry-recognized (and typically published) behavioural or theoretical basis (by contrast, many retail strategies are untested, but this deficiency is then marketed as being special or new);
(iii) focus on efficient implementation (e.g., lower portfolio turnover), and not just investment methodology (by contrast, retail strategies often fail to adequately account for trading risks, such as illiquidity and suspensions, while others seek minor outperformance that can be marketed to clients, but for which dollar-weighted returns are unduly hampered by trading costs);
(iv) have reasonable and published performance benchmarks (by contrast, many retail strategies eschew publicly published benchmarks, instead relying on custom or inapplicable benchmarks for the purpose of manipulating performance reporting);
(v) place little importance on backtests or recent short-term performance (by contrast, many retail strategies use data-mined backtests, which can be easily manipulated to suggest a strategy will perform well in the future, or cherry-pick short-term performance despite evidence that this is among the worst ways to select a manager);
(vi) have low fees or performance-based fees (by contrast, many retail strategies charge such high fees that clients may be worse off than if they had simply held their money in cash);
(vii) apply over long investment time-horizons of between 10 and 100 years (by contrast, many retail strategies place the focus on short-term client retention and therefore take risks to improve short-term performance even if a longer time horizon better suits the client).
The characteristics just described beg a question: is there any reasonable basis for offering different kinds of solutions to institutions and private individuals?
Why Managers Don’t Offer Institutional Solutions to Retail Investors
There are three primary reasons managers don’t offer institutional-quality solutions to retail clients. Whilst the first of these is grounded in economic reality, the remaining two are purely about profit maximization for investment managers and the underlying conflict of interest in our industry.
(i) Economies of scale make institutional solutions cheaper. Retail and institutional accounts do not benefit from the same economies of scale (g., Henderson Rowe’s parent company, Rayliant Global Advisors, has multiple clients with US$1B+ managed using their strategies, whereas most retail accounts are significantly smaller). As a result, it costs more to service retail clients than institutional clients, which is reflected in higher fees for retail clients and correspondingly reduced performance.
(ii) Retail managers do not have a financial incentive to invest in good strategies. Developing institutional- quality strategies is difficult and expensive – and institutional clients occupy an extremely small and highly informed market. In order to tap this market, institutional managers invest primarily in building stronger research and investment capabilities. In the retail market, the situation is reversed. The pool of clients is very large and poorly informed. Accordingly, retail managers do not invest in research or investment capabilities. Instead, they focus on building sales and marketing infrastructure to reach the maximum number of clients.
(iii) Institutional-quality strategies are less profitable. Many of the ways in which retail investment managers make money would never be tolerated by institutional clients. Whereas institutional managers typically charge clients a flat management or performance fee, retail managers employ lock-ups, entry fees, exit fees, investment product charges, and a range of other transactional fees. Retail managers would be unlikely to adopt an institutional model, because doing so would deprive them of too lucrative a source of revenue.
At the end of the day, the most telling distinction between institutional and retail managers is one of transparency. Institutional managers have nothing to gain (and much to lose) by hiding information. As a result, they adopt simple fee structures and avoid complexity in the structure of their investments. They “sell” based solely on the quality of their strategies and the stability of their operations.
By contrast, retail managers can find success by making costs and performance so difficult to understand that prospects feel paralyzed by the noise. They obscure costs through entry fees, exit fees, lock ups, special charges, outsourcing, third-party funds, and complex products. They then invest heavily in sales and marketing materials that hide low-quality products behind high-quality, glossy brochures.
Bridging the Institutional-Retail Gap
Rayliant Global Advisors, Rayliant Global Advisors is an institutional research firm that, through its regulated affiliates, also manages institutional assets. When it acquired Henderson Rowe in 2018, it did so with the express purpose of helping to bridge the institutional-retail gap by introducing institutional-quality solutions to the UK private client market. This is consistent with the vision of Rayliant’s founder and Chief Investment Officer, Jason Hsu, who has a long history of investor advocacy.
As an institutional asset manager, Rayliant has experienced the rigor of institutional due diligence first-hand. Whilst it knows retail investors lack the resources to scrutinize their managers in this way, it nonetheless believes they deserve the same level of care and attention as institutional clients.
As a result, Henderson Rowe is now offering some of the most rigorously researched strategies available on the retail market – strategies developed, monitored and updated by the same globally renowned research team that builds investment programs for some of the world’s largest institutions. This doesn’t mean the strategies are opaque or overly complicated. To the contrary, they are designed to be transparent and sensible. That is what institutional investors demand, and there is no legitimate reason private clients should not expect to receive the same.
Similarly, effective July 2019, Henderson Rowe has implemented one of the industry’s most transparent pricing structures. The firm now generates revenue from new clients exclusively through a simple, straightforward management fee. As with institutions, this model makes it easy for clients to understand what they are paying for Henderson Rowe’s services, allowing them to make informed decisions about whether they feel the service and value provided by their manager is worth the price.
In a future article, I will describe in detail some of the differences between institutional and retail strategies, as well as how the behaviour of institutional and retail investors differs. However, for the moment, I wish to make the following point: every retail client has the same right as an institution to demand transparency as to how its strategies operate and how its fees are paid. This is precisely what Rayliant and Henderson Rowe seek to deliver in London, and we have the pedigree to do it.