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Keeping it local

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RisCura takes debates the benefits of local specialists

Suppose you feel like a good Italian meal tonight. You know of several Italian restaurant chains that offer a reliable, predictable service. They are reasonably priced, the choice of dishes is varied enough; in short: a perfectly acceptable experience. But you live near a neighbourhood with a large Italian population. Families who enjoy eating out. Who want to eat authentic food. Who want it prepared the real way. Who want to eat locally. And there is your dilemma: will you be better served going to a well known chain or a local specialist?

It’s similar in fund management. Large global managers offer reliable, somewhat predictable mandates and philosophies, either as part of a multi-country/multi-region product or by applying their process repeatedly in different jurisdictions. They will have some economies of scale, usually a good sized team and be proficient in areas like compliance, risk management, operational and administrative best practice. As an investor you’re unlikely to get ‘ill’ but are also less likely to achieve Michelin starred returns. They are popular with many clients for good, comforting reasons. Set against these are neighbourhoods of smaller, locally-focused specialists. Some of these will be quite exceptional, others best avoided – you just wish you knew which ones.
Local expertise needs careful due diligene

The more unusual or inaccessible a region or asset class is, the more likely it is that a dedicated local specialist will be able to identify opportunities missed by their larger, global peers. Drawing on local networks, a superior understanding of local information, or simply an ability to go out and verify data or a thesis for themselves can add up to a considerable edge. But local specialisation can come at a price: compared to a large global player they may be less well resourced overall, and less able to withstand a downturn in relative or absolute performance.

Careful due diligence and advice are needed to maximise the benefits of local specialists. Consider a market like mainland China: the asset management industry is barely two decades old, as are the capital markets themselves, while the economy is rapidly diversifying and maturing. Until recently it was quite hard for foreign investors to participate. A fluid environment like this, perhaps more than anywhere, creates a rich opportunity set for the astute local participant, especially one who is able to navigate, interpret and anticipate the local nuances of a fast-changing marketplace. Global managers tend to focus on large, well-known companies (like Alibaba or Tencent) which by definition are better-researched and one must assume more fairly priced. Local specialists who concentrate on ‘second tier’ mid cap names can arguably exploit greater opportunities.

The Chinese market is known to be dominated by retail investors, with a (typically) simplistic, reactive, trend-following approach to investment decisions; an approach which creates more opportunities in the mid-cap market which is underobserved by the global managers, so allowing mispricings to arise. A smart local investor might additionally identify this activity more easily than a global manager – for example, in conversation with their friends, neighbours or brokers – and seek to profit from adopting a more ‘rational’ valuation and decision-making framework.

Smart local investors may also have an advantage in dealing with the heavy state involvement in the Chinese economy and equity markets. Their personal experience of how the state operates, their ability to pick up on potential reorganisations at a corporate or regulatory level can make a material difference to their investment results.
However it may not be immediately obvious who the smart local investors are. Many players (and regulators) are still finding their feet and understanding best practice - though they do have the benefit of template solutions from other countries. Some of the new Chinese asset management firms will be staffed by teams who have brought the retail mindset with them, and now apply it on an industrial scale.

This is where the need for specialist advice comes in. A manager research consultant or multi-manager fund with particular expertise in the region will help to separate the pretenders from the contenders. Understanding the full macro context will be an important input, as will an ability to dynamically adapt to new circumstances – circumstances which are more likely to be local in nature with often quite different local impacts on some sectors over others. But simply choosing a local manager with a glossy brochure is inadequate: operational risks and business risks must be evaluated and weighted up. There benefits of getting it right are clear; the risks of a misjudgement can be significant.

It’s the same as the local restaurant: if you know where to go you’ll have a fantastic night out; if you choose based on the decor you may need a strong stomach.

Lars Hagenbuch, Consultant at RisCura