It's an unmistakable market reality: asset managers have recognized they can no longer be all things to all people. They have come to the realization that they cannot always develop every aspect of the ever-broadening range of increasingly complex portfolio products that their clients demand. As a result, more and more are leveraging their internal capabilities in conjunction with external niche-market expertise by implementing a manager-of-managers (MoM) investment model.
In brief, a manager-of-managers is an investment advisor who hires other professional investment managers, or sub-advisors, to oversee specific aspects of an investment portfolio. A MoM typically focuses more on the manufacturing and distribution of a product, rather than the actual management of the assets. This role is left to the sub-advisors on an outsourced basis whereby the best managers can be leveraged for their particular area of investment expertise. The MoM dynamic creates a symbiotic relationship between both investment advisor and sub-advisor where distribution and manufacturing strengths are aligned with specific investment strategy expertise.
The rationale underpinning the MoM approach is that diversification and balance among portfolios of sector-focused or complex investments can be achieved more readily and cost-effectively by having a group of specialists, instead of a single manager executing the fund's strategy. The MoM assembles a group of investment experts, closely monitors their performance and alters the composition of the team to adapt to market conditions, overall fund performance, as well as the performance of the individual sub-advisors.
A Dynamic Market
The multi-manager structure has become increasingly popular in the asset management marketplace, particularly over the past several years. According to Financial Research Corporation (FRC), sub-advised products comprised $731 billion in '40 Act mutual funds in 2008 and are projected to reach $1.4 trillion by 2014-forecasting a 12% CAGR since the market downturn of 2008.
At Citi, we believe four factors contribute to the increased attractiveness of the MoM model:
* The acquisition of expertise and performance - Faced with the prospect of deciding to build, buy, or rent, many asset managers have chosen the rent option, allowing them to fill both product and performance gaps in the most expedited and cost efficient manner possible.
* The retirement market - Given the negative effect the last 24 months have had on the public's retirement nest-egg, people are working longer and saving more. As a result, the retirement market and its sticky assets are viewed as a huge opportunity. The associated demand for asset-allocation and target-date products, combined with the continued importance of open-architecture distribution, have made the sub-advised model even more attractive.
* The convergence between traditional and alternative asset managers - As traditional retail fund managers have opened up to non-traditional strategies, the expertise required to run these strategies is typically not available in-house. Recent examples include 130/30, absolute-return, and managed payout strategies, which usually require sophisticated hedging capabilities often outsourced via a sub-advised relationship.
* An increased demand for diversification - Tactical global asset-allocation funds, with their "go anywhere" mandate, have become increasingly popular, as have funds-of-funds and international funds, particularly those focusing on emerging markets. The jurisdiction expertise required to effectively run these funds is another opportunity that can take advantage of a sub-advised model.
Role of the Service Provider
In the MoM model, the investment advisor's responsibilities not only include identifying, developing and maintaining distribution partners, but have been broadened in scope to include robust manager selection, asset allocation and risk management. Just as investment advisors look to sub-advisor specialists to complement their investment capabilities, so, too, should they consider a third-party provider to deliver the administration services required in this increasingly complex marketplace.
By selecting the right partner, the MoM will be able to supplement the strength of their offering by leveraging the subject matter expertise and focus that a third party service provider can offer. A combination of thought leadership, continued technology investments and deep experience delivered by the third-party service provider enables the MoM to remain focused on developing and distributing products.
Given the additional oversight responsibilities and associated risk mitigation concerns, when reviewing a service provider's credentials, MoMs should select a provider with robust capabilities:
* High-touch service model - A MoM client is not one-dimensional. Both the investment advisor and the sub-advisor(s) require constant and consistent access to a service team that knows the MoM's portfolio, how it is constructed, and how the MoM and the sub advisor(s) interact.
* Manager on-boarding support - A dedicated team who provides administrative setup services, systems configuration and entitlements, service integration and documentation, as well as ongoing support to optimize operations and pricing.
* Transition management - Replacing an investment portfolio's securities mix with another should be a seamless and transparent process. Service provider alignment with extensive global markets expertise is critical.
* Portfolio analytics - The ability to analyze performance at the portfolio, sub-advisor, strategy and security levels in order to provide key measures and metrics to enable a continuous monitoring of sub-advisor benchmarking.
* Technology as an enabler - A robust information portal with holistic visualization capabilities should provide both the investment advisor and the sub-advisor access to all relevant information delivered in real-time with multiple perspectives and formats.
* Transparency - A compliance-based culture is essential in providing the investment manager with additional levels of safety and soundness surrounding all trading and reporting activities. The service provider needs to understand the ever-changing regulatory landscape in order to better understand the challenges and opportunities faced by the MoM.
* Integrated Service Suite - In order to maximize the total experience, all services should be fully integrated into the core offerings of fund accounting, fund administration, transfer agency, custody, securities lending, middle office and regulatory administration.
Strong Growth Prospects
At Citi, we are optimistic about the prospects for the future growth of the MoM investment structure. In our analysis of the marketplace, we believe the following trends support the continued popularity of a multi-manager product:
* With 2010's 12-month total returns on equity funds looking good, the lure of the equity market's upside should have investors putting their allocations back in place. As a result, investors will start moving out of money markets and other fixed income assets. However, to avoid concentration risk, they are seeking to diversify and are looking at more complex equity products, such as those encompassing international markets, hedging strategies and more esoteric securities -- investment expertise that is not readily available in most asset management shops.
* Continued growth in the retirement space in general, with greater application of asset-allocation products. The retirement space is expected to grow $5 trillion by 2014 (see Cerulli Associates graph), with target-date funds being the vehicle of choice, a product uniquely situated to take advantage of the MoM model.
* As more managers target DC plans and RIA assets, product-neutral, open-architecture platforms offering best-in-breed products will continue to become more important. The MoM model is particularly well-positioned to take advantage of this space, as the use of unaffiliated asset managers in a plug-and-play model allows for efficient adding and replacing of the required investment strategy expertise.
In summary, to succeed in these new market conditions, we believe that fund managers will continue to adopt a MoM investment model-leveraging their in-house capabilities with the external niche expertise of sub-advisors and third party service providers-for the bottom-line benefits of their firms and their clients.
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