Financial institutions across Europe are restructuring their businesses to focus on their core competency: manufacturing – asset management; or distribution – asset gathering.

This has led to sub-advisory becoming a major area of business growth for asset managers in Europe. Scandinavia, Switzerland and the UK are at the forefront of this growth whilst the German, Italian and Spanish markets are starting to show signs of interest.

Cerulli Associates’ research (in The Global Multimanager and Sub-advisory Markets 2003) estimates that $37bn (E30bn) of mutual fund assets have been outsourced in Europe – but their definition is deliberately narrow. The true extent of sub-advisory in Europe is probably three or four times larger and growing rapidly. Increased regulation, focus on profitability and consumer demand for better product is driving sub-advisory growth.

Agreements

Sub-advisory can broadly be described as outsourcing the management of assets to another, external manager. What to include in this definition is subject to debate. Is a manager of managers structure sub-advisory? Or a fund with two or more underlying managers? And what about insurance accounts, which may back a number of insurance products? Where sub-advisory begins and ends is open to interpretation, but the key fact remains that outsourcing is on the rise.

If we look at the most prevalent types of agreement – representing the majority of assets managed – these can be divided into five types, ordered in terms of assets managed and defined below. Competition, brand, legal considerations, client demand and investment structures are some of the many factors which can alter the type of sub-advisory arrangement.

Fund management delegation

This is the most common and simplest of sub-advisory methods. One party employs another to manage the assets of a product – a mutual fund or life insurance fund. In this case, the fund’s prospectus will show who the manager – the sub-adviser – is, in the same way as if the management had been delegated to another part of the same organisation.

Multi-manager

From the sub-adviser’s perspective this is the same as delegation; they are asked to manage a pool of assets in a particular way. But from the sponsor’s perspective the drivers are completely different. In this model the sponsor decides to pick two or more managers and blends their expertise together within one product. For single asset classes this often involves a blend of different styles – growth, value etc – or, more commonly in insurance funds, a mix of managers running different asset classes.

Overlay management

The outsourcing of overlay mandates to sub-advisers is one of the growth segments within sub-advisory. More and more sponsors, particularly those with multi-asset class or multi-manager products, are looking to manage their asset class and/or currency exposure proactively.

White-labelling

Here the sponsor takes advantage of an existing structure – a fund managed by the sub-adviser – and simply rebrands it as their own. The difference from the sub-adviser’s perspective is that they have responsibility for the legal vehicle, not just for managing the assets. This model is perhaps more prevalent in the United States than in Europe.

Model portfolio

In certain markets, sponsors are not allowed to delegate fund management to third parties. When this is the case, but the sponsor still wants to benefit from third party expertise, they can engage a sub-adviser to provide them with a model portfolio which they can then follow. It cannot be said that one model is superior or more efficient than another.

Outsourcers

Who is outsourcing? The short answer is almost everyone who does not regard asset management as a core competency. But the main segments driving sub-advisory at the moment are insurance companies, universal banks and the smaller regional banks.

Insurers – As well as responding to consumer demand, insurers in many markets are looking for ways to become more financially efficient and as a result are looking at ways of cutting fixed costs and improving investment returns. As such, many insurers have sold or are looking to sell/close down their asset management division and/or outsource to a sub-adviser.

Universal banks –There are many reasons for such a bank to decide to outsource all or some of its asset management, depending upon the bank’s strengths and client base. They may want to focus on distribution and outsource all asset management to one or more sub-advisers. Alternatively, they may decide to outsource because they may be getting investment management performance from their in-house teams which is not good enough or cannot be systematically delivered. In addition, a European bank’s clients could reasonably expect their bank to be able to manage European equities or bonds, but may feel it acceptable, even beneficial, for their bank to outsource Japanese smaller companies, US equities or non-traditional asset classes.

Regional banks – This is one of the growth areas in sub-advisory across Europe. This is partly driven by the spread of investment culture from the financial centres of Europe to the regions, creating new demand. At the same time, to compete for assets regional banks are seizing the opportunity to bring in asset management experts from outside their own domestic arena. Often this results in a strategic alliance where the whole asset management function – all asset classes – is outsourced to one sub-adviser.

Client pressure

Client demand lies behind this increase in sub-advisory activity across Europe. Investors are becoming smarter and more demanding, expecting their banks to offer them the widest selection of competitively priced and performing investments. At the same time banks and other distributors are under pressure to deliver profitability and are therefore narrowing their focus.

A recent survey published in association with Goldman Sachs Asset Management revealed that client pressure – for enhanced product ranges or to complete the product portfolio – were the overwhelming drivers behind the sponsor’s decision to outsource. See Chart 1.

The result? Companies are looking outside for solutions that complement or augment their in-house offering. Or in many cases companies opt to outsource asset management entirely to one strategic partner or a range of partners.

Strategies

For those companies which believe that by offering third party products they can capture more market share, sub-advisory arrangements are often attractive solutions. They may not want to see another asset manager’s name too closely identified with their client – ie. through offering another manager’s fund – so they opt to offer a product under their own brand but managed by another manager. This allows them to keep the sub-adviser’s name as visible or invisible as desired.

More recent evidence suggests non-correlated strategies are starting to see an increase in sub-advisory opportunities. Strategies including currency, enhanced cash, quantitative equity and asset allocation are increasingly in demand from sponsors.

Sub-advisory is a largely unexplored but growing business. It requires an institutional asset management capability and an awareness of retail markets. Selection is about performance, process and predictability of returns. But keeping a mandate is about building a relationship. There are very few managers with the capabilities to succeed, but no one leader in Europe. The only sure thing about sub-advisory is that it looks set to grow.

Alex Fletcher, Managing Director, Head of Third-Party Distribution, Europe – Goldman Sachs Asset Management

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