The mutual fund subadvisory business is booming -- doubling in just more than two years to almost $700 billion.
In fact, the amount of mutual fund assets subadvised by investment counseling firms, investment management consultants and others has grown 32% compounded annually since 1995, and continues to pick up speed.
"It will continue to grow because of the need for more diverse products," said Ray Liberatore, research analyst with Financial Research Corp. in Boston.
Subadvising grew 27% alone during 1998 and is expected by analysts to do just as well this year.
One out of every 11 U.S. mutual funds now is managed by a subadviser, FRC reported. One in every nine domestic equity funds and one in six international/global funds is subadvised, according to FRC.
Indeed, investment advisers responding to a Pensions & Investments survey reported they manage a collective $3.5 trillion in mutual funds, of which nearly 20%, or $662.7 billion, is subadvised. U.S. mutual funds overall contained $6 trillion in total assets at the end of July, according to the Investment Company Institute, Washington.
The majority of those subadvised assets are invested in actively managed domestic equity mutual funds.
Boston-based Wellington Capital Management LLC is the leader among firms that responded to the survey, reporting $150 billion in subadvised assets under management as of June 30; about $43 billion is managed for mutual funds wrapped by variable annuities. Wellington also reported the most domestic equity and domestic fixed income in subadvised assets.
Survey data provided by 194 investment advisers indicates a variety of players are involved in this business, from small asset management firms to large insurance companies and banks.
"Subadvising is definitely increasing," said David Silvera, consultant at Investment Counseling Inc., West Conshohocken, Pa.
"The distribution entities, like the big investment banks or the large insurance companies, are trying to forge relationships with partners. They have an infrastructure that is hungry for product and they can't develop it quickly enough. The easiest way is a subadvisory agreement," Mr. Silvera said.
"And unless there's a serious meltdown in performance, those contracts are long lived."
Analysts say subadvising is the next frontier for small management firms that lack significant distribution channels.
Additional fees
Subadvisory business amounts to additional management fees for the firms. This fee revenue is especially important to young firms because it provides them with income and the opportunity to create a track record. Hence the presence, albeit small, in subadvising of firms such as Eagle Asset Management Inc., Sawgrass Asset Management LLC, HighMark Capital Management Inc., Kern Capital Management LLC and Chartwell Investment Partners.
Additionally, subadvising is important to non-retail advisory firms because it provides them with access to the retail customer, to which small institutional firms are generally not prepared to market or serve.
Lincoln Capital Management Co. of Chicago has managed a large-cap growth equity fund for Vanguard Group Inc.since 1987.
"We didn't have any great strategic plan when we started the account," said David Fowler, executive vice president and managing director at Lincoln. He is a manager on the $17.3 billion Vanguard U.S. Growth portfolio.
"We do separate account management. We had a broad base of large corporate defined benefit accounts and Vanguard was looking to make a change and they found us.
"It was nearly a $200 million mutual fund then, so it fit our minimum size requirement and we recognized that it would give us the ability to tap the defined contribution market, but it wasn't a profound strategic decision," Mr. Fowler said.
Ditto for Lincoln's relationship with Frank Russell Co., Tacoma, Wash., for which Lincoln manages nearly $2 billion. Moving into the subadvisory business wasn't a goal for Lincoln. "They found us. It's the accident or benefit of doing what we do well."
Accident or not, subadvising has been a good path for Lincoln. The firm reported subadvising $19.5 billion as of June 30, accounting for 31% of the firm's $62.7 billion in total assets under management.
And if another good subadvisory contract knocks on the door, Lincoln might answer, but they're not making the rounds in pursuit of that business, Mr. Fowler said. "They're Wal-Mart and Target, and we're Procter & Gamble. I don't think it's wildly different from what we see in other sectors of the economy."
Parent-child links
TradeStreet Investment Associates Inc., Charlotte, N.C., ranked second among managers with the most subadvisory contracts. It manages $62.7 billion in mutual funds for its parent company, Bank of America, San Francisco.
TradeStreet manages about $100 billion in total assets.
The P&I survey allows firms that manage assets for a parent or affiliate to report those assets as subadvised as long as a formal subadvisory agreement is in place.
The third largest subadviser is Mellon Financial Corp., Pittsburgh, whose investment management subsidiaries manage $26 billion in mutual fund assets: including $17 billion for Vanguard, $2.4 billion for SEI Corp., $1.3 billion for Frank Russell, $1.3 billion for Domini Funds and $840 million for Consulting Group.
Vanguard's relationships with Mellon Capital and Franklin Portfolio Advisors were in place long before Mellon bought in 1994 its own mutual fund house, Dreyfus Corp.
Mellon executive Ron O'Hanley said despite what seems like a competitive conflict -- the owner of Dreyfus managing funds for Vanguard -- Mellon has benefited from the Vanguard arrangement.
"We will continue to leverage our investment management expertise both internally and to high-quality providers like Vanguard," said Mr. O'Hanley, president of Mellon Institutional Investors.
The $26 billion in subadvisory assets is about 17% of the $141.5 billion in total mutual fund assets managed by Mellon, and a fraction of the $426.4 billion Mellon manages in total worldwide assets.
Denver-based Janus Capital Corp. subadvises $24 billion in assets, but only for insurance companies: including $8 billion for Western Reserve Life, $6.8 billion for American Skandia, $2 billion for Pacific Life, $1.3 billion for Lincoln Life, $1.3 billion for Travelers. About $3.4 billion of the subadvised assets is in international equity, with $21.2 billion in domestic equity. Janus manages $150 billion in total assets, with the subadvised assets accounting for 16%.
"We see these as complementary relationships. These companies are not our competitors," said Janus spokeswoman Shelley Grice. "They are the distribution side and we do the stock picking."
Fixed-income business
Among firms reporting subadvising fixed-income mutual funds, the top 10 run about $57 billion in subadvised assets. Managers leading this business are Wellington, TradeStreet and Pacific Investment Management Co. of Newport Beach, Calif.
Jennison Associates LLC, New York, leads with the most international active fixed-income subadvisory work, $1.3 billion, followed by Strategic Fixed Income LLC, Arlington, Va. at $692 million.
Schroder Investment Management North America, New York, subadvises the most international equity, $9.2 billion, followed by Northern Cross Investments Ltd., Boston,at $7.7 billion and Janus with $3.4 billion.
The survey was sent to about 1,000 investment managers in P&I's institutional manager database.
