As long ago as April 2003, Standard & Poor’s fund analysts in London spotted the first stirrings of optimism among fund managers that, at last, the bear market was over. Signs of recovering strength in the US economy, together with stockmarket history, argue in the optimists’ favour. Only twice in the last century have markets fallen for more than three successive years, and stockmarkets subsequently rebounded strongly. In the UK, the last year has seen the FTSE 100 index, representing around 80% of the market’s value, up 28%. The FTSE All-Share index, which includes about another 600 companies, has done even better, up around 32%. S&P’s London-based fund analysts also observed that most bullish of all are the small specialist, or boutique, investment houses, such as the Bermuda-based Sagitta Asset Management, founded in 1995; the long-established JO Hambro Investment Management or the relative newcomers, Thames River Capital and Lloyd George Management. All have less than £2bn of assets under management, all tend to invest in equities bottom-up and for total return, and all run funds that hold S&P fund management quality ratings. Thames River, which launched its first fund only in 1998, now runs no fewer than three S&P-rated funds. Small firms offer the advantage of a more flexible investment approach by getting away from the tyranny of peer groups and benchmarks to seek absolute returns. There has been a steady migration of talented investment professionals from the big players to start-up companies. Some argue that fund management is, in any case, better executed by small numbers of people handling more modest amounts of money. Boutiques are cheaper to run, too, in that the bulk of an asset manager’s costs is in salaries. If the trend-spotters have got it right, in future the big institutional investors will allocate their assets more judiciously; their allocation to equities will be split between indexers and the boutiques, rather than indexers and the big firms, or the medium-sized operations that often simply form a part of a bank or insurance company empire. According to research by Sector Analysis, boutiques are seen as offering better service as well as greater flexibility, and their specialisation is a plus point with some institutions. Owning asset managers has fallen out of fashion: the big players’ margins are being squeezed and mid-sized firms stand to be hit hardest by tougher regulations, such as a ban on soft commission arrangements and capital adequacy requirements. It seems the small boutique asset managers could be the winners in a changed investment world. The economic fundamentals make all asset management business appear copper-bottomed, though. Nothing short of mutually assured destruction will change the fact that populations in the developed world are getting older and living longer, meaning that more people will need to live on invested capital. Governments are trying hard to shift the burden of paying for pensions from the state to the individual. Changed accounting rules mean that companies, too, are far less willing to risk balance sheet losses by shouldering the pension burden for their employees. That must have the effect of boosting the sale of savings products. It is therefore perfectly rational for the fund management industry to be optimistic. All they have to do is sit tight until markets start rising again, companies start making profits again and investors pile back into equities. But the situation could be more complex than that. Investors may well put less of their money into equities than in the past. Stocks might have outperformed bonds over the long term, but that information is not necessarily useful to investors suddenly made the sole authors of their fate in retirement. Views that returns on equities may be lower in future years is bad news for asset managers hoping for a return of the equities boom. A real return of 5% a year over the next five years, compared with 15% from the S&P 500 in 1990-2000, would make managements fee of 1-3% out of the question. High costs and poor performance continue to attract hard-eyed scrutiny from both investors and regulators, and companies have been suffering. During the bear market, the value of assets under management fell with the markets, reducing fund managers’ percentage fees in absolute terms; investors took money out, reducing the volume of assets under management, and some of the assets that remain were moved out of equities and into bonds. And running bonds earns less money than running equities. Banks and insurers have been rushing to divest themselves of their loss-making fund management arms. However, successful small firms probably have more reasons to be cheerful than most. Although there has been some speculation that the bull market conditions of the last few months may not continue, several of the Sector Updates released by S&P’s fund analysts, covering the later periods of 2003, have indicated that many European-based fund managers are optimistic. The UK Growth Mainstream sector report, for example, mentioned that although there are managers that see the economic outlook as less rosy – and who therefore invest in more stable stocks, there are also more optimistic managers who tailor their portfolios accordingly. The recent Japan sector update also noted that many fund managers investing in Japan view the outlook as positive in the long run. It remains to be seen whether this optimism will continue to be borne out by results, but in the meantime, in many regions, an element of confidence is present.