Life as a subadviser has been very good to money managers, especially institutional managers with broad investment capabilities and good track records.
While a few managers have been active in the subadvisory side business for years, most companies didn't start focusing on the distribution channel until five years ago, and many companies are only now taking a stab at attracting assets from other money managers.
Asset managers in Pensions & Investments' survey universe of 771 companies (P&I, May 27) managed an enormous amount of money as subadvisers in 2001. In fact, the 50 largest subadvisers managed slightly more than $633 billion in worldwide institutional assets as of Dec. 31 on behalf of other money managers.
The dollar total on other side of the coin - those managers that hire subadvisers - also is impressive. The top 50 manager-of-managers companies assigned $553 billion in worldwide institutional assets to other firms.
The discrepancy between the two lists probably reflects one of the major dynamics of the subadvisory market: Much of the new money entering the market is from smaller insurance companies and regional banks that are creating mutual fund families, hiring outside managers to take over existing funds and converting existing pools of assets to mutual fund formats with outside managers. Those companies don't typically participate in P&I's annual money manager survey, the source of the data for these rankings.
That market dynamic, plus continued flows into subadvised mutual funds by retirement plans and the growth of the variable annuity market, will push growth of the subadvisory market into double digits for at least the next five years, said John Benvenuto, a senior consultant at Financial Research Corp., Boston.
FRC tracks only the growth of subadvised long-term mutual funds, which, along with variable annuities and separate account wrap programs, comprise the subadvisory niche. Mr. Benvenuto said he expects "growth in the subadvisory market will remain very strong," with projected growth of the long-term mutual fund portion of the subadviser market in the low teens for each of the next four to five years.
According to unpublished data from FRC, subadvised assets under management in long-term mutual funds dropped to $455.5 billion in 2001 from $469.4 billion the prior year, while market share of net flows to subadvised funds rose to 21% of all long-term funds, from 14.3%. One in every eight mutual funds was subadvised in 2001, up from one in nine the year before. Subadvised assets as a subset of total long-term fund assets rose slightly to 10.6% in 2001 from 10.1% the previous year, said Mr. Benvenuto.
"The money coming in probably is a mixture of new money from bank and insurance sources and old money being moved into subadvisory relationships. A lot of subadvisory money now comes from retirement plans, and that will remain a strong source of assets for managers like Vanguard, Frank Russell and SEI," he said.
One of the earliest participants in the subadvisory market was Wellington Management Co. LLP, Boston, which began managing mutual funds for Vanguard Group Inc., Malvern, Pa., nearly 30 years ago. That relationship was worth $97.8 billion to Wellington at year-end 2001. Wellington has parlayed its subadvisory experience with Vanguard into multiple lucrative relationships, with 64.2%, or $196 billion, of its total worldwide institutional assets coming from the subadvisory channel as of Dec. 31.
Lisa Finkel, the head of marketing at Wellington, declined to comment on the company's subadvisory success, citing a company policy against speaking to the press.
Wellington placed first in P&I's ranking of the top subadvisers, topping its nearest rival, Deutsche Asset Management, New York, by $136 billion. Deutsche subadvised $60 billion in worldwide institutional assets at year's end, followed by J.P. Morgan Fleming Asset Management, New York, with $37.3 billion; Alliance Capital Management LP, New York, $37 billion; and Pacific Investment Management Co., Newport Beach, Calif., $25.4 billion.
The top five subadvisers are part of "a handful or two of organizations that are very committed to the subadvisory structure. They've dedicated staff, made a conscious effort to pursue this business and have built up a big practice," said Christopher McNickle, managing director, at consultant Greenwich Associates LLC, Greenwich, Conn. "There's a much longer list of asset managers with a lesser commitment that have built up their businesses organically, without much concerted effort. And then there are the companies that are just leaning more about the niche and figuring out if they want to participate," he added.
Mr. McNickle said the subadvisory business was built primarily on the premise in the last five to 10 years that open architecture would prevail within the asset management business. Clients were expressing the need for a wide range of investment capabilities from a diverse group of money managers through a single provider. "The preferred model has evolved to a single provider that offers proprietary investment management, plus access to outside money managers," Mr. McNickle said.
As for money managers, subadvisory relationships offer an opportunity to "plug their capacity into other areas they don't currently participate in - institutional pension assets, mutual funds, variable annuities, wrap, whatever. They are trying to plug into multiple access points and get as entangled a relationship as possible with a client," said Jim Folwell, consultant, Cerulli Associates Inc., Boston.
Forced to focus
Despite a natural reluctance on the part of asset managers - banks in particular - to admit there is an area of investment management at which they don't excel, many money managers are being forced by poor markets and sinking assets to analyze their businesses and focus on core competencies, Mr. Folwell said. "Managers are much less reluctant to farm some of the assets out and offer strategies from outside managers in order to concentrate on the strategies they are good at. After all, whoever controls the distribution controls the relationship, and also the larger part of the fees bucket," he said.
Open architecture has better defined the role of distributor and asset manager, said Mr. Folwell, "putting the asset manager back into a pure asset management role. It's a very good business, not having to handle distribution and client service. What's better than not having to handle 10,000 shareholder accounts?"
Richard M. Goldman, head of Deutsche's institutional business in the Americas, agreed with Mr. Folwell's sentiment. Deutsche managed $14.68 billion for Fidelity Investments, Boston, as of Dec. 31 in a series of large indexed mutual funds, for example, without ever having to handle an individual fund investor.
Deutsche got its first big subadvisory assignment from Fidelity some years ago and has accepted additional passive business since then, but it hasn't been a focus, Mr. Goldman said. Instead, Deutsche looked through its lineup of investment strategies about two years ago for actively managed and enhanced indexed products that generate high alpha. "We didn't have tremendous distribution capability and knew we needed to find strategic partners," Mr. Goldman said.
Deutsche went from having one person dedicated to subadvisory business two years ago to a 16-member team that now is focused on marketing and client service. The subadvisory business was Deutsche's largest area of asset growth and personnel expansion in the two-year period, Mr. Goldman said, and it brought in subadvised accounts from Prudential Financial, Newark, N.J.; SEI Investments, Oak, Pa.; American Skandia Life Assurance Corp., Shelton, Conn.; MetLife Inc., New York; ING US Financial Services, Atlanta; the Managers Funds, Norwalk, Conn.; and Salomon Smith Barney Inc., New York, among others.
Deutsche now is looking at ways of providing alternative investment management - from hedge funds to private equity and real estate - as a subadviser, and has one client in that area, which Mr. Goldman wouldn't identify. He expects alternatives to be extremely popular with companies looking for subadvisers, especially those pursuing the high-net-worth market.
J.P. Morgan Fleming is another big player that is considering ways of offering alternative investments as a subadviser, after a very successful five-year focus on the subadvisory area, said George C.W. Gatch, managing director. Mr. Gatch was brought on to jump-start J.P. Morgan Fleming's subadvisory efforts in 1995, when the company realized its product depth and experience in customizing portfolio management for large pension funds would suit the niche very well. Depth was important, Mr. Gatch said, because he realized early on that clients likely would want to expand their subadviser relationships and use them to manage other investment strategies. Like pension funds, money managers wanted to keep the number of outside managers they worked with to a minimum. Now, between 70% and 80% of the company's subadvisory clients use J.P. Morgan Fleming to manage more than one strategy, and they are serviced by 15 dedicated subadvisory staff members in the United States and 10 overseas.
J.P. Morgan Fleming doesn't offer subadvised alternatives now, but it is in the midst of product development with several clients. The asset manager also is doing some consulting with potential clients on how the clients can incorporate a hedge fund of funds into their product mix, Mr. Gatch said.
Alternatives already are a source of growing subadvisory assets for PanAgora Asset Management Inc., Boston, which managed $6.9 billion as of Dec. 31, or 52.9% of its total worldwide institutional assets, as a subadviser. While the bulk of PanAgora's subadvised assets are managed for its two part owners, Putnam Investments Inc., Boston, and Nippon Life Insurance Co, Tokyo, an increasing flow is coming in to be managed in hedge funds of funds, mainly market neutral strategies, said David Jonas, national sales director, third-party distribution.
"There's been a lot of talking on the corporate side about hedge funds and alternatives. We're answering a lot of questions right now from interested managers," Mr. Jonas said.
PanAgora also is marketing its quantitative management skills with some success. "After two years of poor markets, investors want managers with fundamental skills. Many managers are beginning to realize that they need quant input to existing portfolios or to add pure quant capabilities for investors. Managers that want subadvisers don't want plain vanilla. They need managers with the ability to customize their approaches. And with a high entry barrier into the quant area, subadvisory becomes a very good option to access these strategies," Mr. Jonas said.
Alternative investment management opportunities likely will make subadvisory work an even more attractive prospect for money managers. Subadvisory assignments already contribute significantly to their worldwide institutional assets. Almost half of the top 50 subadvisers received 15% or more of their worldwide assets from other money managers and nine of the top 50 managers received more than 30% from subadvisory work in 2001. Besides Wellington and PanAgora, other managers with a third or more of their total worldwide institutional mandates flowing in from subadvisory mandates were MFS Investment Management Inc., Boston, with 37%; Peregrine Capital Management Inc., Minneapolis, 60%; Westpeak Global Advisors LP, Boulder, Colo., 36.8%; Fred Alger Management Inc., New York, 35.2%; and Cadence Capital Management, Boston, with 37%.
Among managers of managers, on the other hand, the percentage of assets passed to other managers is extremely high. General Motors Asset Management, New York, for example, which ranked first in P&I's ranking with $98.1 billion, passed 88.2% of total worldwide institutional assets to subadvisers. Second-ranked Vanguard, with $68.7 billion managed by external managers, passed 25.8% of total worldwide institutional assets to subadvisers; third-ranked SEI Investments, with $52.6 billion, passes all of its assets to subadvisers; fourth-ranked Frank Russell Trust Co., Tacoma, Wash., with $43 billion, passed 91% to outside managers; and fifth-ranked Diversified Investment Advisors Inc., Purchase, N.Y., with $39 billion, passed 88.6% of assets to other managers.