Mike McNabb is the director of State Street Global Advisors of Boston's institutional sub-advisory group, which offers a variety of unique sub-advisory services, such as interim management.
McNabb discussed recent trends in the sub-advisory business with Mutual Fund Market News' Andrew Brent. An edited version of their conversation follows.
MFMN: A recent survey by the Financial Reporting Council indicated that nearly 11% of all mutual fund portfolios are sub-advised. Has the business grown at your own firm, and if so, what do you think are some of the reasons for that?
McNabb: There has been a tremendous amount of growth. I think there are two driving forces resulting in the growing interest on the part of mutual fund companies to hire external managers. The first is, while fund complexes are trying to build long-term relationships with their clients, we have all suffered through a long period of bad performance. It's very difficult to have a top-decile manager and have that manager maintain that position over extended periods of time. These are very, very challenging times; the capital markets are increasingly difficult.
So, some firms are finding it is easier to sub-advise a fund out to a highly performing manager, or even to use the sub-advisory arrangement to put an arm's length distance between themselves and bad performance.
The other thing is that the market is demanding new and innovative products and they want them immediately. For most mutual fund complexes it's very difficult to create products as quickly as the market is demanding them. The cost of research, development and marketing is increasing tremendously. Are you going to spend your budget on the origination and marketing of new products, or are you going to spend it on the investment side?
Many fund companies are finding it is more expedient to find partners that leverage their core capabilities. For a tremendous amount of mutual fund companies, their core capability is distribution, and they're very willing to talk to firms, like SSgA, for these types of sub-advisory relationships.
MFMN: In addition to the asset retention benefits of sub-advisory relationships, is there a direct marketing advantage in hiring a well-known investment manager? Do any of SSgA's clients, for instance, promote the fact that their funds are managed by SSgA?
McNabb: Yes, there are advantages to hiring a well-known manager, but it varies. Everyone's business model is different. Everybody's core competency is different. Everybody's branding value is different. Some of our clients originate the assets in the retirement market. In that market, they are very comfortable talking about SSgA as a sub-advisor because we're very fortunate to be the largest manager of retirement assets in the country. That labeling and association brings value to their story. In other instances we have mutual fund complexes that may be associated with a wirehouse, where their brand is very strong and it's not necessary for them to leverage our strength as one of the largest money managers out there. It really becomes a business issue.
MFMN: With $15 billion in sub-advised assets, where does SSgA rank within the sub-advisory marketplace?
McNabb: We define the investment management market as asset gatherers, a term we've coined to encompass mutual fund companies, insurance companies, recordkeepers and banks. That's anyone who is in the business of originating and retaining assets. Most of the research out there is being done in two categories, either insurance companies, specifically variable annuities, or mutual funds. If you were to take a look at the category of just mutual funds, we probably rank eighth or ninth, but I expect we'll grow pretty dramatically over the next couple of years.
MFMN: How do you expect to grow? Specifically, how do you market your sub-advisory services to potential mutual fund clients?
McNabb: We created a business group a year and a half ago, called the institutional sub-advisory service group, which I head here. It focuses on the retirement market and not-for-profit market, which includes foundations and endowments.
That group contains sales, marketing, client service, operational support as well as access to a group we call the advanced research center, which is a problem-solving group of academics and investment professionals who we bring to our clients. These various teams address all of the components of a client relationship.
MFMN: How big is your group and how many clients do you serve?
McNabb: Right now, the institutional sub-advisory group is comprised of seven people. The individuals who work for me have various backgrounds, ranging from mutual fund investment management, to operations, to compliance, to client service.
We serve 49 clients today. In terms of our revenue growth, we expect more than 30% revenue growth over the next several years.
MFMN: Do you ever approach potential clients that have not yet indicated that they are seeking a sub-advisor?
McNabb: It's very difficult to sell anything in this channel. If you are the chief investment officer or you are the director of new product development for a mutual fund complex, I'm not going to sell you anything because you're going to know where to go when you need it. What I want to do is create a relationship where you view me as a resource. It's very important for me to understand and to have preliminary discussions with you about where you see your growth coming from and what your business model is. In addition to providing investment management, we also have created a series of services within this group that we offer to clients as well, which is why the group includes marketing, operations and research.
MFMN: Can you be more specific about what these services are and how they benefit your clients?
McNabb: We put this together because we realized there are business issues that we need to solve for clients before we earn the right to provide investment management. One of the services is called Interim Manager Services. In one instance, the Citizens Funds came to us with a sub-advisor that had performance that had deteriorated to the point where they decided to find a new manager. We were able to offer a solution on an interim basis.
Depending upon how the mutual fund complex is structured with the SEC, this arrangement may vary. In this case, we stepped in for a period of 180 days as the interim manager. The first thing we did was evaluate the current portfolio where we felt the risk profile was out of line. We then made some suggestions as to what we would do as the interim manager, and they gave us the go-ahead to do that. And then we helped them communicate that message to the marketplace.
MFMN: What happened after the 180-day interim assignment?
McNabb: Actually, we still sub-advise that fund, a customized, socially screened portfolio. We spent a lot of time with their in-house research group and their investment professionals and, we believe, helped improve their filtering process and the performance of the fund. We earned the right, I believe, to step into that portfolio long-term.
MFMN: It can't be easy to step in as an interim manager. What advantages do you offer clients?
McNabb: Many professionals in the business know of our concentration on controlling risk. For a fund complex with a poorly performing manager that faces the risk of losing assets, this is a strong point to communicate to clients.
We also make sure to communicate to the Morningstars and Ibbotsons of the world and the market in general that State Street Global Advisors has stepped in as an interim manager.
MFMN: Do you ever share sub-advisory duties?
McNabb: We've seen a lot of interest, especially with our quantitative strategies, in providing ways to complement another manager. For instance, we are dealing with a client right now, who I am not at liberty to name, who has a fundamental international manager with a fairly concentrated portfolio.
They're looking for us to complement that manager's style. Because we have experience in both fundamental and quantitative management, we know that the return streams of a fundamental portfolio behave very differently than a quantitative portfolio, so that by combining the two together you can reduce the volatility of that international allocation, and hopefully keep your clients' assets longer.
MFMN: What is the fee structure for the interim manager services?
McNabb: We're guided by what's already in place. You can't change what's currently being paid to the sub-advisor without going to a proxy, and that's counter to what we're trying to do, which is get in there very quickly and solve the problem. So we pretty much step into the shoes of the incumbent manager.
MFMN: Would you ever reject an opportunity to step in as interim manager if the fee being paid to the current manager was below a certain point?
McNabb: That's a good question. We would because I think it needs to make sense to both parties, both to State Street Global Advisors as well as the client.
