While most mutual fund advisers focus efforts on growing their proprietary mutual funds, some fund advisers have chosen to commit resources to building sub-advisory businesses.
Delaware Investments of Philadelphia, Fred Alger Management of Jersey City, N.J. and OppenheimerFunds of New York are among those that have recently focused on building their sub-advisory services.
Usually, a fund adviser partners with another investment adviser to manage a non-proprietary mutual fund, or a portion of another company's fund portfolio under a sub-advisory arrangement. While the fund's sponsor usually maintains title to the fund and receives the management fee, it pays out a portion of that management fee to the contracted sub-adviser who agrees to perform the day-to-day management.
A number of successful sub-advisory investment management partnerships can mean additional revenue for a firm and can enable it to exploit its investment expertise in other distribution channels. By sub-advising, a firm avoids having to deal with distribution problems and the expenses of managing a proprietary fund, such as shareholder servicing or maintaining a network of wholesalers.
Sub-advisory relationships can be formed both by mutual fund and variable annuity companies, said Avi Nachmany, executive vice president and co-founder of Strategic Insight of New York, a data tracking and consulting firm.
"In the year of multi-managed funds, where everyone is looking for a specialist, the expansion of sub-advisory relationships has been significant and is likely to continue," said Nachmany.
Delaware Investments began as in institutional investment firm then expanded into the retail sector. The firm has focused on expanding its sub-advisory business over the past two years, said Frank Staves, vice president and director of sub-advisory services. Until then, Delaware had only managed a small-cap portfolio for Paine Webber of New York, and a high-yield bond fund for Diversified Investment Advisors of Purchase, NY.
"This gives us a lot more ways to deliver investment services," said Staves.
Delaware now has $5.5 billion in sub-advised assets, almost 10 percent of Delaware's total $50 billion in assets under management. The sub-advisory figure includes both $2.6 billion in non-affiliated managed assets and another $2.9 billion in assets it sub-advises for its parent company, Lincoln Financial Group of Philadelphia.
Its most recent new sub-advisory business is the management of the First Funds Capital Appreciation Fund, a fund managed by First Tennessee Bank of Memphis, Tenn. (MFMN 5/1/00) Delaware will begin managing the fund June 1.
Delaware went into the sub-advisory business to increase revenue and the effort has been fruitful, said Staves.
"We are projecting that this is the fastest growing part of our business," Staves said.
Delaware was joining what it saw as a growing trend toward fund companies outsourcing investment management - including to direct competitors with a complementary competency.
But it can take many months to form sub-advisory arrangements and being a sub-adviser can be difficult, said Staves.
"You need resources to support business development," he said. He has found that most sub-advisory searches are done in-house.
"You have to go and knock on doors," he said.
While the competition for fund sub-advisory business is not intense, clients are sophisticated and would not interview marginal firms nor hire a competitor unless they possessed a superior capability, said Staves.
Firms seeking sub-advisers put candidates through rigorous reviews. And every firm is looking for different qualities in their sub-advisers.
"Every relationship is 100 percent unique," Staves said. There's no one-size-fits all approach, he said.
Often fund companies seeking to hire sub-advisers expect a hybrid product to be created especially for them. They want a product that is sufficiently different from any competing product the potential sub-advisory firm currently offers, said Staves.
There are probably 50 to 100 firms that might seek sub-advisory services, said Staves. Small fund complexes do not usually have the resources to consider hiring a sub-adviser, and large fund complexes with in-house talent would not consider looking outside the firm.
While the insurance industry, anxious to sell proprietary variable annuities, has been more receptive to the idea of hiring outside managers for products, the variable annuity universe is still small, said Staves. And within that universe, the top 20 product providers hold most of the assets, he said. Right now Delaware is only seeing between 10 and 20 sub-advisory opportunities per year.
Fred Alger Management has also focused on building its sub-advisory business. That effort has helped Alger attract its current $20 billion in assets under direct or sub-advisory management, up from the $2 billion in pension fund money it managed 14 years ago, said Ray Pfeister, executive vice president at Alger.
"That's where our growth has come from," he said. Alger's core competency is in the large-cap growth sector.
Alger first considered pursuing sub-advisory relationships in 1987, said Pfeister. The firm's executives realized that it would take vast resources to compete with larger, better known firms for more retail investors.
Alger now has more than 50 clients to which it provides sub-advisory services, said Pfeister. Within the last 10 months, Alger has added three new clients. In July 1999, Alger agreed to become the sub-adviser for the Enterprise Internet Fund, one of the Enterprise Group of Funds of Atlanta. In January, Alger was chosen as one of the three multi-managers for the SunAmerica Focus Portfolio, one of the proprietary mutual funds of SunAmerica Asset Management of New York. The SunAmerica fund is co-managed by Marsico Capital Management of Valencia, Pa. and Jennison Associates of New York. In February, Alger assumed the sub-advisory function for the Sentinel Flex Cap Opportunity Fund, a new equity fund from Sentinel Funds of Montpelier, Vt.
"It's a relationship business," said Pfeister. "Relationships, at the end of the day, outweigh performance."
The sub-advisory business is more risky than the proprietary mutual fund business since fund companies' boards of directors can abruptly terminate sub-advisory contracts, said Pfeister. Fund sponsors' advisory contracts on the other hand are much more difficult to terminate, he said.
Firms contemplating becoming sub-advisers should consider whether the corporate cultures of potential advisory partners jive with its own, said Pfeister. Alger, for example, makes it a policy not to sub-advise no-load mutual funds because of its own intermediary-sold structure for proprietary products.
"We don't do no-load funds because we don't want to compete with our [broker/dealer] clients," Pfeister said.
