The practice of delegating fund management work to third parties is increasingly gaining traction. Typically, investment firms outsource these tasks to specialist ‘sub-advisers’ if they want to fill a gap in their product range, respond to changing regulations or increase their operational efficiency.
Eighty per cent of European firms which have established partnerships with a limited number of carefully selected asset managers, to run all or part of their client assets, have experienced significant growth in their sub-advisory activity.
Over the past three years, delegated assets rose by more than 20 per cent for around half of the firms taking part in PWM’s 15th annual sub-advisory study.
The research gathered information from 26 institutions, including asset and wealth managers, private banks and insurance companies, with combined client assets of close to $5tn, of which $684bn (14 per cent) are run as separate accounts by external managers.
More than 90 per cent of respondents expect their sub-advised assets to grow over the next three years, using existing managers or appointing new ones to run additional mandates (See Fig 1).
The expansion has been more obvious in markets which better lend themselves to this approach, such as the UK, Switzerland, the Nordic countries and Italy, where local asset managers enjoy significant size and have a long-standing tradition of outsourcing. Scale is a key requirement for investment mandates, enabling distributors to negotiate lower fees with investment partners, akin to institutional levels.
“After many years of speculation, interest in sub-advisory is finally growing, as it is an intelligent way for distributors to move to a guided architecture,” suggests Paolo Biamino, head of strategy, third parties and business at Italian asset manager Euromobiliare AM, a long-standing user of sub-advisers.
The delegated approach enables a firm to build model portfolios and a recommended list of funds, managed by partners but proposed as in-house or white-labelled solutions, responding to specific client needs.
In Italy, where the exceptional growth of the retail fund market in recent years was driven by direct fund sales, with major international fund houses finding fertile hunting grounds there, local distributors have embraced the delegated approach to tighten their grip on advisers and take back control of product distribution.
A key trend has been the emergence of ‘privileged partnerships’, where a sub-adviser is tasked to run more than one mandate. This model typically leads to cost savings and operational efficiencies, says Mr Biamino.
But setting up a new mandate is a lengthy process. More than 50 per cent of respondents take between one to six months to finalise sub-advisory agreements (See Fig 2). This explains why sub-advisers are perceived as strategic partners, with such partnerships described as “marriages”, rather than love affairs. Almost 60 per cent of the sample report sub-advisory relationships lasting five years or more (See Fig 3).
This longer-term strategy is best suited to large asset management firms, with a wider range of investment capabilities and solid operational infrastructure, although it can clash with retail distribution networks’ desire to propose “hot” products, riding the wave with fashionable fund houses.
The most used sub-advisers in PWM’s research are established brands, including BlackRock, Invesco and JP Morgan AM, followed by Fidelity and Wellington, with GSAM and Investec AM not far behind.
Asset managers seeking to enter this lucrative business need to guarantee appropriate operational infrastructure to support delivery of separate accounts. From an investment perspective, they must have adequate resources to address multiple bespoke mandates.
As a result, our respondents believe the best sub-advisers are likely to gain greater market share, leading to a concentration of delegated assets controlled by a handful of sub-advisers (see p33). At each firm, the top asset manager today runs more than 30 per cent of sub-advised assets, for almost a third of respondents (See Fig 4).
But there is still room for smaller players. Our sample uses more than 700 sub-advisers, including many mid-sized and smaller firms. Only 15 per cent say they favour large institutions, with 50 per cent preferring smaller firms (See Fig 5). Bringing in a new, specialist fund house, is often seen as an added value, differentiating factor.
“Be it a well-known brand or not, we put a lot of emphasis on assessing solidity and stability of the investment team, because if the investment team breaks apart, the entire thesis for picking the manager is gone,” says Anders Bertramsen, head of external products at Nordea Asset Management.
“But if my selection team can find a hidden gem, somewhere in the US or Asia and bring it to Europe, then we can add a lot of value.”
Others praise the ‘multi-boutique’ approach, where “even in large asset managers, teams… have the right incentives and long-term alignment of interest often found in boutiques,” explains Brian O’Rourke, head of investment partnerships at Mediolanum Asset Management.
The Dublin-based asset management arm of the Italian banking and insurance group has further honed its sub-advisory focus over the last two years, adding new investment managers and awarding several mandates in a variety of asset classes.
“We were keen to build greater conviction in portfolios, to remain diversified but not overdiversified by manager. Using mandates gave us scope to do that,” says Mr O’Rourke, explaining that mandates represent core allocations in client portfolios, and mutual funds are used for satellite holdings. Channeling client assets to fewer managers allows “a more competitive fee structure”, with lower total expense ratios for clients across product ranges.
Sub-advisory also provides access to a greater range of investment skills offered by innovative managers which do not have distribution capabilities in Europe.
Improving client offerings drove Italy’s FinecoBank to set up an asset management firm in Dublin last year, today managing almost €11bn ($12.4bn), of which €4.6bn is sub-advised by 17 investment management partners. Most of these are already present on FinecoBank’s retail platform. The bank will now rely mainly on these partners for developing new products.
Fee squeeze
Sub-advised mandates enable wealth managers to improve their risk and better respond to regulatory requirements, by providing full transparency of underlying holdings.
More than 75 per cent of firms believe regulations including MiFID are driving distributors to form partnerships with a small number of managers, leading private banks to go down the sub-advisory path (See Fig 7).
“Regulation is a very strong catalyst for firms to reconsider their business model, and MiFID is one example, driving people to consider whether building a separate account framework is appropriate or not,” says Amit Popat, European head of wealth management at Mercer. The global consulting firm offers manager selection and research capabilities, while also building investment vehicles within which managers are appointed on a segregated basis.
As pressure on margins increases, and prices potentially decrease, given higher transparency on costs, a sizeable distributor may be able to ‘squeeze’ the sub-adviser’s fee, gaining a higher percentage of the total fee, compared to mutual fund distribution.
“A higher fee is not the sole driver of fund management delegation on a stand-alone basis,” believes Mr Popat. “An additional motivation is that it allows distributors opportunity to enhance client engagement, enabling them to grow market share, and potentially increase profitability.”
The challenge for firms moving to a separate account framework is one of providing appropriate, supporting infrastructure. This can be built in-house or outsourced to external firms, which can help them make it scalable.
Deutsche Bank WM has been toying with the idea of building its own sub-advised platform and offer DB WM labelled bespoke products for a few years now. Despite being convinced of the benefits of this approach, business priorities have been in other areas, explains Ian Crispo, global head of hedge fund and mutual fund selection for Deutsche Bank WM.
Creating the bank’s own sub-advised platform would require an infrastructure similar to that of an asset manager, with all the operational, risk and compliance requirements, he explains.
The private bank however, keeps a small number of sub-advised, actively-managed strategies in its discretionary portfolios, dating back several years.
More recently, it has partnered with three large bond managers to launch customised fixed income products, an area which it intends to grow. These baskets of bonds are invested on a ‘buy and hold’ basis to maturity, structured in a fund format, enabling the bank to create customised risk-return profiles. These specific exposures, reflecting the bank’s CIO views, proved particularly popular among clients last year, due to rate rises and spread widening, says Mr Crispo.
Sub-advising is a core part of the retail business of Deutsche Bank, providing tailored solutions to clients in the bank’s main markets, including Italy, Belgium, Spain and Germany.
Exclusivity agreements
When solutions managed by third parties are sold to external clients, as opposed to a predominantly captive network, exclusivity of distribution becomes a key factor, to avoid conflicts of interest.
“When we partner with a manager to complement our range with a new investment strategy, exclusivity is key,” states Didier Chan-Voc-Chun, head of multi-management at UBP. This leads the Swiss player to prefer smaller companies, which can offer exclusivity agreements in core markets in Europe and Asia.
“When we identify an area of expertise we don’t have internally, and we think it may take time to develop it and be good at it, then we are not shy about partnering with the best sub-advisers in their class,” claims Mr Chan-Voc-Chun.
UBP enjoys long-term partnerships in US and Japanese equities, but more recently has selected specialists to meet specific client demand in more niche strategies, such as Danish mortgages.
The minimum threshold for a mandate is set at SF100m ($100.5m), or at least that should be the minimum size to reach. Otherwise, it is not worth putting in place such infrastructure, he explains.
UBP also uses sub-advisers for Ucits mutual fund alternatives, with most recent launches being a long/short market neutral and a long/ short debt strategy.
Getting to know external managers’ capabilities in depth is very important, says Mr Chan-Voc-Chun, and expecting them to run very bespoke mandates does not make sense. “If we see true value in a strategy that a manager is running, we want to constrain them as little as possible.”
Finding the balance
Within asset management firms, there needs to be a fine balance between assets managed in-house and assets run by third parties, explains Nordea’s Mr Bertramsen.
The Nordic firm manages €220bn, of which more than 10 per cent is delegated to 20 managers. “I don’t think there is a make or break percentage for externally managed products. This is very much down to whether the asset manager understands the reasons for offering white labelling products,” he says.
Having started sub-advising in 2006, the approach is engrained in Nordea’s business model, and enables the firm to offer clients a complete product range, otherwise only available to large asset management firms.
It is critical, adds Mr Bertramsen, to offer clients a “unique” solution, to gain a competitive edge, difficult to achieve in today’s highly competitive market. This means quality and investment capabilities of the sub-adviser’ team, and exclusivity of distribution agreements, become key manager selection factors (See Fig 10).
Sub-advising investment solutions is also a way to strengthen Nordea AM’s strategic partnership with the group’s private bank, as the external products unit is also responsible for selecting managers for the private bank.
In PWM’s research, the most sub-advised asset classes are in the equity space, with US, global, European, and Japanese equities at the top, while EM debt is the most outsourced asset class in fixed income (See Fig 11). Going forward, firms plan to award new mandates mainly in equities, with GEM coming top, followed by European, US, China and Japanese equities. Fifteen per cent of respondents plan to give new mandates in alternatives over the next 12 months.
At Nordea, the large majority of its white labelled assets are in fixed income. But going forward, Mr Bertramsen expects greater sub-advisory activity both in equities and alternatives. The firm recently launched a sub-advised European long/short fund, with a market neutral solution already in the pipeline.
Last year, a long/short, event-driven strategy, run by Amber Capital, became the latest addition to Lombard Odier’s sub-advised fund platform, ‘PrivilEdge’. Launched in 2014 to offer clients “externally managed funds in a Ucits format that may otherwise be difficult to access”, today the platform holds assets of more than SFr5bn across 28 funds. Its partners include specialists such as Robert W. Baird, Moneta and Sands CM, as well as global managers JP Morgan, BlackRock, Wellington, Ashmore, T. Rowe Price, and Fidelity.
“Given the increasing volatility we see in the market cycle, we believe it is a good time to diversify portfolios through active alternative strategies,” says Stéphane Monier, CIO of Lombard Odier’s private bank. “More corporate activity in Europe will make the market conducive to event-driven strategies,” he says.
