Competition and demand for the best asset managers are fueling a growth in subadvised funds, which are gathering assets faster than those managed internally.
Assets in subadvised funds grew at a compound annual rate of 27% from 2003 to 2006, compared with 17% for internally managed funds, according to a study from Financial Research Corp. of Boston. Over the same time period, subadvised funds' market share grew to 14%, from 10%.
At many firms, the decision to hire a subadviser was made for strategic reasons: Fund management companies were eager to enter the international and alternative-investment markets but lacked the in-house expertise, so they turned to outside managers. Other reasons for hiring a subadviser are to bolster performance, handle increased assets under management and secure a great manager at a competitive cost, observers said.
Since August 2003, the result has been a 52.2% increase in the number of subadvised funds, compared with a 12.4% increase in funds industrywide, according to research from Morningstar Inc. of Chicago.
Moreover, more than 2,290 funds listed a subadviser as of August, with $2.3 trillion in assets under management, compared with 6,653 distinct funds and $8.3 trillion overall.
However, of paramount concern are the fees the funds charge, said Samuel Braun, director of investments at Financial Strategy Network LLC of Chicago. "You have to look at the costs relative to everything else you are looking at," he said. "For advisers, it's to make sure that the client gets the best deal."
Expenses vary among funds, with some offered at fair prices, while others charge exorbitant fees, Mr. Braun said. "But the good thing is that you can find a competitively-priced subadvised fund where you can access a great manager."
If the fund company doesn't keep the management fee, that can squeeze the margins at the firm, said Christine Benz, director of mutual fund analysis at Morningstar.
"The biggest part of the expense ratio is the management fee," she said. The trade-off is greater distribution and the chance to sell more, even if fees to the subadviser are increasing. Smaller companies see subadvised funds as a way to expand their offerings.
"The megagroups have their own offerings in-house," said Lou Stanasolovich, president of Legend Financial Advisors Inc. of Pittsburgh.
"The mid[size] and small boutique firms are doing it to expand their offerings. Some of the organizations have to grow their product base or die."
When a firm relies on multiple outside managers, it can demonstrate a diversity of investment styles under one umbrella, Ms. Benz said. For instance,
The Vanguard Group Inc. of Malvern, Pa., is No. 1 in subadvised assets un-der management, with $376 billion, representing 30% of assets at the firm.
Vanguard has 26 external subadvisers that are managing 65 different portfolios or portions of portfolios. "We get the expertise of an established manager. We get a diversity of thought in our funds," said Joe Brennan, a principal and head of portfolio review. "We have 26 different research units working for us."
Vanguard's two in-house groups focus on fixed income and quantitative investments. "We don't have the traditional stock-picking styles. That is what we look for — firms to manage externally," Mr. Brennan said.
But relying on subadvisers too heavily might be ill-advised. "How will the funds differentiate themselves at all if everyone is using the same marquee names?" asked Ms. Benz.
Those business concerns have led some companies to explore exclusive agreements with managers. At John Hancock Funds LLC of Boston, for example, the majority of the 58 retail funds are subadvised with exclusive relationships. The focus is on the style, the type and the investment strategy of a fund.
"It is our intention that the subadvisers that we work with will not end up managing a substantially similar offering for any of our competitors," said Keith Hartstein, president and chief executive of John Hancock Funds.
The subadviser model was expanded after the company was purchased in 2004 by Manulife Financial Corp. of Toronto. "The subadvised model works for us, because we have all of the other things in distribution and the name brand," Mr. Hartstein said.
Understanding subadvised funds is important for asset allocation, said Kipley Lytel, managing partner at Montecito Capital Management of Santa Barbara, Calif. "We need to know the allocation and what the correlation is," he said.
Job security for subadvisers can be tenuous at best. Some firms cycle through managers quickly, said Ms. Benz. "It's not like firing the guy down the hall," she said. "These are hired hands you can fire at will. It's easier psychologically." But that may not be cause for concern.
"The thing we really like to see are fund boards who are not afraid to go out and find somebody better," said Rick Brooks, vice president of investment management at Blankinship & Foster LLC of Solana Beach, Calif. "If you want exposure in an asset class, rather than develop a second-rate team internally, I'd rather see you go out and find a team that does it very well."
Sue Asci can be reached at [email protected].
