Navigating through the coronavirus crisis

Ben Dear, CEO of Osmosis Investment Management, talks about the difficulties for smaller asset managers in the current environment and why industry consolidation is a threat to innovation.

It has been an uphill battle for small and mid-sized boutiques in weathering the storm caused by the global pandemic. Ben Dear, CEO and founder of the sustainable asset manager Osmosis Investment Management, says that for some, it has become purely a matter of survival as investors are unable to perform operational due diligence, which means no new inflows. “The challenge now for small and medium-sized managers, even for those with good performance and well-capitalised firms, is how to raise money from investors that require some form of operational due diligence performed before committing capital,” he says. “Especially in a time of stress, that extra level of due diligence becomes even more important to ensure that the manager has the capital in place and that they are able to keep the business going, not just financially but operationally as well.”

Ben Dear has headed the London-based boutique since its inception in 2008. During the past five years, the firm’s factor-based investment style with an environmental focus has attracted investors such as the Swedish national pension fund AP1, IKEA Foundation and the UK’s Oxford Endowment Fund.

Ben Dear says the coronavirus pandemic has been an eye-opener for many smaller investment firms. When the epidemic started spreading and countries started enforcing strict quarantine measures, Osmosis, with USD 1.3 billion (EUR 1.2 billion) in assets under management, was faced with how to keep things running despite not being able to meet face-to-face with potential clients.

On the other hand, Ben Dear says it was encouraging that despite the initial shock, many investors adjusted relatively fast to the situation. “One of the prime brokers actually conducted a pretty comprehensive institutional survey with asset owners around the world on this very question,” he explains. “They were asking whether asset owners would be willing to allocate to new managers that have shown some consistent performance in this downturn. The initial response, when the markets corrected, was that investments were paused. Eight weeks later, however, when asked the same question, 40 per cent of the asset owners said they would only allocate to existing managers if they had performed. However, another 40 per cent said they would actually conduct operational due diligence without the need for an onsite physical visit.”

In order to keep things going despite the slower inflows, he notes that it is important to have a strong balance sheet. “If your income reduced 20 per cent and your new flows are paused, combined with a level of uncertainty that not all flows will crystallise, it’s crucial that you can maintain your business as it is until the client decides to take you to the investment committee. If you have had to restructure and reshape your business, it will not be the business the client was looking to invest with three or five months ago. When you’ve got those basic building blocks in place – your capital, your fund performance and your team – you can compete and win assets because asset allocators are still being paid to do a job, they have work to do.”

When asked how investors have approached the new situation from a due diligence point of view, Ben Dear says many have been looking at buying into the services of a third-party provider, but points out that there are fiduciary issues around relying on such services. “And then, of course, referencing through existing clients takes on more importance , having previously conducted operational due diligence they can offer an additional level of comfort,” he adds.

Furthermore, he notes many investors have been keen to develop new ways to conduct their due diligence. “We actually have a big book of potential business in Australia that was just at the stage of operational due diligence as the pandemic hit. The asset owners are keen to work with us to come up with ways that can help them to conduct that operational due diligence. They have been very forward thinking and that has been very encouraging,” he says. He is quick to point out, however, that the broader consultant market has been less encouraging, believing the fault in the business lies in the way it is being conducted. “Consultant models tend to be client driven, meaning that the work undertaken is down to a specific request from a client, but at the same time clients won’t speak to managers unless they get a recommendation from a consultant. So there’s this closed-loop architecture that you need to navigate your way through," he says.

Ben Dear says many smaller and mid-sized investment firms have struggled in the current situation where more investors are relying on consultant ratings that smaller companies are often excluded from. “The danger is that a whole breed of managers around the world, which I would like to call the innovators of the industry, will have to be bought out by larger players and go under larger umbrellas. The operational cost of launching business in our industry was high before but now the barriers to entry are so high, it will discourage many from taking that leap of faith,” he says.

He also points out that innovation is one of the keys for surviving the current crisis and smaller, more nimble and entrepreneurial managers are often better positioned to innovate than larger asset managers with more rigid operational frameworks. “I think with innovation, a new normal will emerge,” Ben Dear predicts.

His own firm’s digital strategy has included the recruitment of a company that will produce videos about Osmosis’ investment performance and strategies. Ben Dear says video conferences have also become the new normal. “If people weren’t familiar with video conferencing before this, they certainly are now and I think that’s something that will continue long after this crisis and these new processes will normalise, he says. “We actually did an investor presentation the other day through a video call and we had 47 investors from 12 different countries joining the call. Before that, an event took up GBP 50,000 (EUR 55,703) from our marketing budget and two to three weeks from my marketing team’s time. So there will be great efficiencies that will come out of this as well.”

With the current situation looking to linger on for quite some time still, Ben Dear says that there will inevitably be more consolidation on the horizon within the asset management industry. However, he believes the truly good and innovative products will be able to weather the storm, no matter the size. Those with deeper strategy issues, however, will find themselves in deep water. “If you’ve been linking ESG to quality for the past two or three years and the tide goes out, and you’re down significantly to your benchmark, then you’re going to have a few problems. Unless you can really justify and explain it. And that’s part of the broader issue with ESG, which is if you’re just overlaying ESG and you’ve got 47 underlying ESG factors, it is going to be a challenge to define what delivered the underperformance,” he says.

However, while many struggle to explain the underperformance, Ben Dear says he believes there will be many valuable lessons to be learnt in the process. “Overall I think the industry is making great strides and for asset owners with longer term investment horizons, the recent performance of the majority of ESG funds will hopefully accelerate the pace of change. Nordic asset owners in particular were very early to adopt sustainability approaches and there foresight has been rewarded. Wherever we hold discussions in investors around the world, they always refer to the Nordics as having been early champions of sustainability, and as we emerge from this crisis, we hope they learn to follow this lead, he comments and adds: “Never waste a good crisis like Winston Churchill said.”

Nevertheless, many smaller and mid-sized managers will not survive the crisis. Ben Dear says that he knows of peers that have been looking to sell their business due to the lingering crisis. “I know of firms that have been approached by potential buyers,” he says. “Those firms have seen their assets shrink 30 per cent or more, which has had a significant impact on revenue. They can’t distribute in the current environment, and any ongoing due diligence processes have stalled. You have to ultimately think what’s best for your team – not what’s best for you or your shareholders. There’s no way I would criticise anyone selling to a larger partner. It’s just the unfortunate end result of the cogs in the distribution cycle seizing, and as a consequence there’s no doubt that we will see some consolidation in the industry.”

When asked whether Osmosis has been approached, he says that the board has had four offers on the firm before the crisis. “In a way, it’s very flattering that a large institution is interested in what you’ve built and wants to buy your people and your idea. That means we’ve done something right. But nevertheless, we have rejected approaches, because we believe in our ability to grow further under our own brand. Plus, we didn’t want that entrepreneurial and innovative atmosphere that exists within a smaller firm to be diluted underneath a larger brand. I’ve seen it happen before and that’s great if you’re in it just for the money, but for Osmosis there’s a larger imperative at play. Part of the company’s DNA is based on a collective desire to build a substantial business together as a team. So no, we’re not currently for sale and we’re not actively seeking a buyer . And to be completely honest, even if I wanted to, unless it was a perfect alignment of interests I doubt my team would follow. And I’m nothing without my team.”

Despite being adamant that about not selling the firm, the US-based Capricorn Investment Group bought a 13.1 stake in Osmosis in late spring, opening up new doors for distribution across the Atlantic. ”The timing one could argue was optimal, but it was the culmination of over two years of discussions and due diligence both ways. They were launching a new fund to invest into sustainable asset managers, and we were beginning to role out our business plan for the North American Market. To find a partner who shared the same principles and philosophy, with the capacity to facilitate the seeding for our strategy in the region while allowing us to remain majority-owned by staff, is a perfect partnership. Like the Oxford University Endowment who increased there shareholding last year, they not only invested to target better risk adjusted returns but can see the long term opportunity for growth in sustainable investment. Its the long term thinking that resonates as although the pace of change is accelerating, there is still much work to do,” Ben Dear explains the reasoning behind the deal.

Ben Dear hopes the industry will ultimately be shaped by the crisis into becoming better and more innovative. “It will be quite hard for some firms and a crisis becomes quite Darwinian. The better products that will survive and flourish will be those that have a core philosophy driven and supported by a robust investment thesis. It will lead to responsible investors being truly responsible. On the other hand, depending on how long the crisis will continue, the consolidation in the industry might lead to an oligopoly with a few large cross-asset managers dominating the landscape and consequentially innovation dies. You end up with homogenised groups of funds with similar approaches left fighting on price, which might offer some advantages for the end investor. There is no one approach to ESG, new ideas need a chance to get established and I do worry how feasible this will be in the short to medium term,” he warns.