Sub-advising mutual funds is becoming another form of distribution for firms that can maintain solid investment performance but have limited ability to sell retail funds broadly, a new study suggests.

Mutual fund companies continued to increase their use of sub-advisers in 1999, according to Financial Research Corp. of Boston, a financial services tracking and consulting firm. The number of funds that use sub-advisers and those funds' assets under management increased for the eighth consecutive year in 1999, FRC said. Sub-advised funds accounted for nearly $33 billion in net sales of long-term funds in 1999, or 9.8 percent of total industry sales, FRC reported.

Sub-advising effectively has become another channel of distribution for money management firms that can show and sustain strong investment performance, said Raymond Liberatore, associate director of research at FRC. That is important in an industry in which the manufacturers of products and the products themselves - mutual fund firms and funds - far outnumber effective distributors, Liberatore said.

"It's essentially a distributors' game today," Liberatore said. "It's not a manufacturer's game."

FRC included the data in a report on sub-advised mutual funds. A summary of the report was released May 11.

In sub-advisory relationships, a mutual fund adviser hires another firm, or sub-adviser, to manage the money in a mutual fund. The fund adviser usually takes the lead in providing marketing and distribution for the fund. The adviser usually has better name recognition than the sub-adviser and possibly a sales force that can distribute the fund. The fund's sub-adviser and adviser divide the management fees the fund earns.

FRC found that institutional money managers and even some retail fund firms increasingly are looking at sub-advisory relationships as a means of increasing their business without having to build an extensive distribution network, Liberatore said. Sub-advisers have the infrastructure to manage money but usually do not have a means of distributing their funds broadly, Liberatore said.

The largest fund sub-adviser is Wellington Management Co. LLP of Boston, according to the FRC report. Wellington ended 1999 with approximately $100 billion in assets under management through sub-advisory relationships, according to FRC.

The remaining top five sub-advisory firms and their approximate sub-advised assets under management according to FRC are: Deutsche Asset Management of New York, $37 billion; Primecap Management Co. of Pasadena, Calif., $20 billion; Lincoln Capital Management Co. of Chicago, $19 billion; and Schroder Capital Management of New York, $13 billion.

Overall sub-advised assets under management grew from nearly $338 billion in 1998 to approximately $426 billion in 1999. The number of sub-advised funds increased from 677 to 704 during the same period.

"It's a growing marketplace," Liberatore said. He said he saw no reason to believe the market would peak any time soon.

The sub-advisory market is dividing into two segments, Liberatore said. Firms that sell institutionally-oriented funds and use sub-advisers - such as SEI Investments of Oaks, Pa. and the Managers Funds of Norwalk, Conn. - require very little sales support from the companies they hire as sub-advisory firms, Liberatore said. SEI and Managers Funds sell to investment advisers and emphasize their oversight of the sub-adviser's performance and investment style.

Another group of companies that includes those that sell their funds primarily to retail investors, requires sub-advisers to provide sales support, Liberatore said. Advisory firms in this group also are asking their sub-advisers to help with SEC filings, compliance issues and prospectus development, Liberatore said.

Sub-advising "is just another type of distribution that you support," he said.

While sub-advising provides a benefit for the sub-advisers, it also offers a means for firms that have retail distribution to offer their products with relative ease. Advisers can readily fire sub-advisers whose investment performance begins to lag, Liberatore said. It is easier to hire sub-advisers than it is for firms to build their own money management expertise, he said. And companies that use sub-advisers rather than building their own expertise do not have to worry that a hot portfolio manager or team will be hired away, Liberatore said.

"It's just an easier process," he said.

Insurance companies are the most likely among financial services firms to hire sub-advisers, he said.

Sub-advisers usually receive about 50 percent of the advisory fee, Liberatore said. That ratio varies among asset classes, according to the FRC report. For example, equity fund sub-advisers received on average 49 percent of the advisory fee, according to the report. For tax-free funds, that ratio drops to 46 percent, according to the report.

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