Adoptions find good match between small, large firms

Once overlooked, so-called fund adoptions are proving their worth as a long-term development strategy for large mutual fund companies.

In the past two years, firm such as Charles Schwab Corp., Pioneer Investment Management Inc. and The Dreyfus Corp. have adopted mutual fund assets by striking subadvisory agreements with various money managers.

And officials at the companies say they are interested in taking in strays again.

"So far, fund adoption has worked very well — well enough that we could continue to explore a good opportunity if it comes up in the future," said Charles Cardona, a Dreyfus vice chairman.

Since John Hancock Funds, Boston, first adopted mutual fund assets in the early '90s, fund adoption has evolved into a unique mode of consolidation. It enables an investment firm to take over a mutual fund — or funds — with an established track record that it can repackage and market instantly as part of its own family. The firm from which the fund is being adopted stays on as subadviser, overseeing day-to-day operations while benefiting from the stronger distribution network.

Fund adoption is "like leasing with the option to buy," said Lars Schuster, director of subadvisory services at Financial Research Corp., Boston. "More fund groups are going this route."

Mr. Schuster said he expects between eight and 15 adoption agreements a year, affecting 30 to 40 funds with a combined value of $2 billion to $3 billion.

Executives at New York-based Dreyfus are interested in exploring opportunities in areas such as large-cap growth and large-cap value, as well as "capacity constraint" strategies, including small-cap and emerging markets equities, Mr. Cardona said.

To date, Dreyfus has adopted five funds. Next month, it expects to take on two more: the $32 million Thompson Plumb Select Fund and the $30 million Thompson Plumb Blue Chip Fund from Wisconsin Capital Management Inc., Madison, Wis., pending shareholder approval.

Officials at Charles Schwab, San Francisco, also are considering making more adoptions following a successful agreement with AXA Rosenberg LLC, Orinda, Calif., nearly a year ago, said Jana Thompson. Through the deal, Schwab picked up 11 U.S. mutual funds, putting them into a new group of mutual funds, the Laudus Group; Ms. Thompson is president of Laudus. This was Schwab's first adoption deal.

"We are most interested in rounding out our offerings of domestic equity funds," Ms. Thompson said, noting her chief interest is in large-cap and small-cap aggressive growth.

While not all investment management companies have holes to fill, some do not want to miss out should a worthy fund present itself.

"We believe our fund family is complete," said Steve Graziano, executive vice president, strategic marketing, at Boston-based Pioneer, which completed its first six adoptions in 2004. "But that is not to say we would not be opportunistic if a unique situation showed up."

In 2004, there were seven adoption deals announced involving a total of 19 mutual funds and a combined $1.4 billion in assets, FRC's Mr. Schuster said. A year earlier, there were 10 adoptions totaling 31 mutual funds and $3.9 billion in assets.

Prior to that, the pace of adoptions was much slower. Fund firms announced six adoptions in 2002, four in 2001 and two in both 2000 and 1999, according to FRC.

In the current environment, small mutual fund shops are ripe for the picking. Many come with strong track records but lack the brand recognition to grow assets in a tough market. They also are eager to hand off aspects of their business that are costly or burdensome — including distribution, marketing and growing disclosure and compliance responsibilities.

"Fund adoption gave us the freedom to stay where we are and focus on managing money," said Greg D'Amico, president of IPS Advisory, Inc., Knoxville, Tenn. "We needed to make a change to provide an opportunity for growth."

In a deal expected to close in March, IPS plans to give its Millennium and Frontier funds, with combined assets of roughly $70 million, to Integrity Mutual Funds Inc., Minot, N.D.

Adoptions also allow for more autonomy than an all-out acquisition.

"My fear was that an acquisition would dramatically change all the dynamics that have allowed us to perform for clients and shareholders," said Thomas Plumb, president of Wisconsin Capital Management and portfolio manager of the Dreyfus Premier Balanced Opportunity Fund. But that hasn't happened, he noted."Our investment management is independent," Mr. Plumb said. "That's basically why this is going to work."

For large fund families, adoption is seen as a way to provide diversity, complete a product lineup or align with a better-performing fund. Also attractive is that adoptions are more cost-effective than acquisitions.

"We're adding more product through our existing infrastructure, which actually lowers the marginal cost of sales," said Mr. Graziano. "There were no incremental expenses" associated with adoption.

Both parties in the adoptions are banking on long-term growth of fund assets, and will typically settle on a 50/50 fee split, said Cindy Zarker, senior analyst at Cerulli Associates in Boston.

Overall, adopted assets do undergo a growth spurt. Consider the 31 funds rebranded as part of fund adoptions reported in 2003. The combined assets, $3.9 billion at the time of adoption, were $5.8 billion as of Nov. 30, a jump of about 50%, according to FRC.

Asset growth by individual fund families also is noteworthy. For example, funds under the Laudus brand at Charles Schwab now total $2.25 billion, up from $1.7 billion when the adoption was completed, Ms. Thompson said.

The adoption "was a great jump-start," she said. "We didn't alter the way AXA Rosenberg is managing money, but we were able to leverage their track record and products they had in place."

Pioneer also has been successful. When the adoption of two funds from Oak Ridge Investments LLC Chicago, was finalized last February, the combined assets totaled $24 million. Now, the newly renamed Pioneer Oak Ridge Large Cap Growth and Pioneer Oak Ridge Small Cap Growth funds have a combined $61 million. (Pioneer has a 49% interest in Oak Ridge.)

"We have an army of people to sell for them," Pioneer's Mr. Graziano said. Pioneer will also adopt the $44 million Cullen Value Fund run by Cullen Capital Management LLC, New York, into its lineup early this year.