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Low-Cost Funds Gain Ground, As RIAs Pick Up Market Share

Independent registered investment advisers continue to gain on national wirehouses, making it imperative for asset managers to offer distinctive, low-cost funds, speakers said at the FundForum USA 2010 conference in Boston.

Broker-dealers continue to be important distribution partners to the mutual fund industry, commanding 32% of sales in 2009, up from 30% in 2007, according to Strategic Insight. But registered investment advisors' market share soared to 37% in 2009, up from 25% in 2007.

"This makes it important to meet the unique needs and investment sophistication of RIAs," said Dennis Bowden, senior research analyst with Strategic Insight.

"RIAs may be growing 10% a year, but they are very disparate" since they are far smaller than national wirehouses. This makes this a highly challenging channel, noted Carter Sims, head of U.S. intermediary distribution at Schroder Investment Management.

Thus, the best way to reach RIAs is with unique products, said Mark Staples, managing director of Wachovia Securities. "There's been a paradigm shift. Investors are looking for a story they have not heard before," Staples said.

While it may not be easy for asset managers to differentiate themselves, that is the key, agreed Keith Hartstein, president and chief executive officer of John Hancock Funds. John Hancock is trying to do this with a new action plan for advisers to ease investors off the sidelines into core fixed income funds or into a portfolio that emphasizes both income and growth.

Because they work independently, RIAs are also far more sophisticated than wirehouse brokers, he said. They want access to portfolio managers and frequent updates on their holdings and investment outlook so they can be better informed for their clients, he said.

"We want to know how the funds fit our clients' risk appetite," said Peter Matoon, chairman and CEO of RIA firm SCS Capital Management. "Those discussions are more profound than, 'Here's my product.' The world is more centered on risk management than on returns."

In addition, there is tremendous pressure for brokers and RIAs to sell low-cost funds, since mutual fund wrap programs now comprise 60% of sales, and commission-based sales are only 35%, Bowden said.

"National broker-dealer program sales are largely dependent on investor re-engagement in equities, but a more conservative approach," Bowden said. "Equities continue to be a significant portion of fee-based platforms, but funds picking up traction have changed to more flexible mandates than can protect on the downside. Thus, mutual fund wrap programs are more diverse."

Fund companies today need to sell through multiple channels, including wrap programs, retirement platforms and the sub-advisor market, Sims said.

Financial Research Corp. analysis shows that sub-advised assets have fluctuated over the past decade, but they are projected to grow to $1.6 trillion by 2015, up from $1 trillion in 2010, said Steve Graziano, president of Touchstone Investments.

Sub-advisory agreements are another sales outlet that can offer tremendous opportunities to asset managers that have strong-performing funds, Hartstein said.

In fact, this is the only model John Hancock uses. Hancock now has 45 sub-advisory agreements for its lifestyle and multi-asset manager funds. "We are looking for superior managers with long-term track record," Hartstein said. "Sub-advised funds are easier for product development because when you have an investment idea, you can shop the market for expertise. If it is a single-manager fund" that is being sub-advised, "we want exclusive rights to build distribution, at least a three-year track record and $1 billion in assets."

Graziano concurred that by hiring a sub-advisor, asset managers can find the best experts and respond quickly to investment styles that are in favor. "Use of sub-advisors accelerates speed to market, relative to homegrown investment management. Sub-advisory is a growing opportunity and a natural strategy extension for institutional managers," Graziano said.

Because the portfolio of sub-advised funds that John Hancock has amassed offers a complementary array of investments, with 22 of the funds earning four or five Morningstar stars, Hartstein said, the firm is on track to increase sales 43% this year to a record $9.3 billion, up from $6.5 billion in 2009, and for 2011 has an additional 35% sales target increase.

Touchstone looks for asset management firms that are stable, with a proven and lasting investment discipline and qualified personnel. "The investment discipline must be differentiable and consistent, and performance has met expectations," Graziano said.

The keys to a successful sub-advisor include forming a true partnership and making their money managers available to gatekeepers. "They must communicate changes to us because we can't have any surprises," he said.

"We need to thoroughly understand what we are providing our clients" in sub-advised funds, agreed George Riedel, head of intermediary sales at T. Rowe Price. "Information flow is critical, including sources of out- or under-performance. Those are table stakes."

Likewise, T. Rowe looks for sub-advisors that offer marketing support and use proprietary research tools to enhance in-depth investment discussions with its wholesalers.