Asset managers are scrambling to boost assets and enter new markets while keeping costs down into partnerships that separate responsibility for sales and clients from actual investment.
Enthusiasm for “subadvisory” contracts is particularly high among European money managers looking to enter the US market and institutional managers hoping to tap individual investors. This is because the arrangement allows them to tap into the US retail market without having to invest in a large sales force.
Asset managers on both sides of the Atlantic that have historically offered mutual funds are also entering into similar deals as a way to enhance their investment strategies in fast-growing sectors such as exchange-traded funds or separately managed accounts.
In a subadvisory relationship, the primary fund manager owns the fund and is responsible for collecting and handling client money. The subadvisor is responsible for investment decisions: how the money is spent.
“The most effective subadvisory set-up is very similar to a strategic partnership. You effectively hire distribution,” said Ju-Hon Kwek, senior partner who leads McKinsey’s North American asset management practice.
Total US assets in subadvised funds where unaffiliated asset managers share management fees nearly doubled between 2013 and 2021 to $3.1tn before falling in 2022 along with the broader bond and equity markets to $2.4tn, according to the provider. ISS Market Intelligence data. Growth has been particularly fast in ETFs, where assets have more than tripled.
For Scottish fund manager Baillie Gifford, her first subadvisory contract in 2003 with fund giant Vanguard proved transformational. Global subadvisory assets under management have nearly tripled since 2012 to $64bn, and these arrangements now account for a quarter of the group’s total AUM and half of its North American business.
“Our partnership with them is a real acceleration of the North American business. It almost seals the deal,” said partner Nick Jones. “You get access to a bigger market and don’t have to bear the cost.”
Most fund managers don’t disclose how their fees are split, but ISS MI Carl Robinson estimates that for a fund with a management fee of 60 to 70 points, the subadvisor will receive 30bp or less.
British fund manager Schroders first became a subadvisory offer in 2016 when it entered into an agreement with Hartford to carry out investments with assets of $ 3bn.
“We decided to outsource our mutual fund business because we weren’t getting traction and we didn’t have a big enough sales team,” said Phil Middleton, chief executive of North America for Schroders, which is now subadvisor for 52 funds with $46.7bn in assets.
Large distribution houses such as Vanguard and Hartford tend to cut deals with two types of subadvisors: those with strong brands that are part of the fund’s name and those that specialize in certain investment areas that do not have large firms in-house.
“You get the benefit of M&A without doing the transaction,” says James Thomas, partner at Ropes & Gray
Fund platforms spend a long time considering managers’ records, governance and performance before agreeing to a deal. “This is a very long cycle of getting to know you and the dating process. It is very important for both parties to get it right,” said Jared Buell, head of intermediary distribution for North America at Vontobel Asset Management. The Swiss group has US subadvisory arrangements with Virtus and American Beacon and is looking to expand.
When Vanguard added Ariel Investments as a subadvisor to its existing Explorer Value fund in early 2022, the appointment came after years of cultivating larger fund houses. Ariel, one of the largest minority investment firms in the US with $14.6bn AUM, hopes that the arrangement will help it persuade other companies to include Ariel options in their employee pension plans.
“It’s a day when we’re trying to get more Americans to participate in retirement [savings]to connect to our story and performance [means] there’s an excitement that won’t be there,” said Malik Murray, Ariel’s head of business development.
Vanguard has used subadvisors for five decades, and monitors the relationship closely. It recently began using a variable fee structure that rewards subadvisors for beating benchmarks and penalizes them for failing over three to five years.
Long-term performance is important, but so are other factors such as whether funds remain focused on certain specialties, said Dan Reyes, head of the global portfolio review department. “We are looking for drift style and where he got his ideas from,” he said.
When the market falls AUM and therefore costs, more asset managers will find subadvisory offers attractive because they allow each side to expand without large financial investments and the combination creates economies of scale, said Stephen Erni, partner at Bain consulting: “The open architecture of the system is really the wave of the future.”