Sub-Advisors Face Public Scrutiny
August 6, 2001
With market performance dreadful for most funds, there has been a rapid increase in sub-advisor switches, right?
Despite a couple of high-profile changes earlier this summer, apparently not. Sub-advisors, who are hired by fund companies to manage portions of their assets, may be more closely scrutinized by the advisors of the funds they manage than ever before. But if they are, it isn't showing up in the numbers--at least yet. But what may be changing is the way fund companies approach and publicly announce such scrutiny.
In the past month, at least two firms have issued press releases regarding changes in their sub-advisory relationships, creating a perception that funds are monitoring their sub-advisors even more closely than they have in the past, said John Benvenuto VP of research at Financial Research Corp.
However the reality is that turnover of sub-advisors last year was approximately 10% and there are no indications that turnover is rising this year, Benevenuto said.
American Skandia's press release announcing its decision to replace Janus with Pilgrim Baxter as sub-advisor to its small-cap portfolio generated a fair amount of media attention, primarily because it involved Janus, a firm that has lost a significant amount of assets since the onset of the bear market.
The press release also thrust Janus into the glare of the media's spotlight (See MFMN, 7/23/01), said Benvenuto. "The awareness of market (performance) is up. Janus being replaced three years ago wouldn't have been news," he said.
Typically, funds disclose changes in sub-advisors to the Securities and Exchange Commission and investors, but Skandia took the unusual step of issuing a press release.
In a similar move, Litman/
Gregory Advisors of Orinda, Calif. issued its own press release the day following American Skandia's announcement, stating it would be closely reviewing its sub-advisory relationship with Franklin Mutual Series. The press release was in response to Franklin's announcement that CEO Michael Price had resigned, and it would reorganize the Mutual Series' team of portfolio managers (See MFMN, 7/30/01).
The press release was a good public relations move for the firm and was made for shareholders' benefit, said John Coughlin, chief operating officer for Litman/Gregory. Although it did not actually replace Franklin Mutual as sub-advisor to its Masters' Select Value Fund, the firm decided to issue the release to let shareholders "know that we are in the process of revisiting due diligence on Franklin as a firm," Coughlin said.
Skandia's announcement marked a change in disclosure policy on such moves, according to Michael Murray, chairman of Skandia's investment committee.
In May, Murray took on the responsibility of monitoring Skandia's sub-advisors and decided to change the firm's policy on disclosing sub-advisor changes. The press release was part of an effort to provide institutional and retail investors greater disclosure of the firm's decisions on its sub-advisors, he said.
The new policy underscores Skandia's aggressive monitoring of its sub-advisors and may be unique in the fund industry, according to Murray. "I don't know of anyone else who does it," he said. "I think most firms are complacent on this."
American Skandia replaces between two to three sub-advisors a year, representing about 10% turnover, Murray said.
Sub-Advisor Turnover Rate
That's close to the industry average, according to Benvenuto who said that although the number of sub-advisor replacements has risen overall in the past year, it has remained fixed at roughly 10% in the last couple of years.
Indeed, more fund companies contracted a sub-advisor to run a portion of their portfolios last year, amounting to $11.1 billion in new sub-advised assets according to FRC.
Sub-advisors are typically replaced for one of three reasons: A change in portfolio management, straying from the fund's investment objective or prolonged underperformance to a relative benchmark.
Generally, funds are slow to replace a sub-advisor for poor performance alone and will give a sub-advisor at least a couple of quarters to improve. However, management changes or style drift in combination with underperformance can prompt a fund to replace an advisor more quickly.
Frank Russell Co., which pioneered the multi-managed fund concept, rarely fires a sub-advisor for poor performance, said Greg Stark, director of client services. The Seattle-based firm, with $66 billion in assets held in multi-managed investments including retirement plans, mutual funds, managed accounts and institutional funds, tries to keep turnover of its sub-advisors low by conducting thorough research on each manager before it hires them, he said.
Sometimes management changes or changes in the fund's investment objective necessitate a change in sub-advisors, but Russell would prefer to make minimal changes because it's disruptive to the operation of the fund, he said.
So while switching a sub-advisor looks like a fund company is paying attention and actively managing the management of their clients' assets, too much movement can look erratic--and as if the company didn't know what it was doing in the first place.
While Russell takes a more hands-off approach to the management of its sub-advisors, it watches for events that could impact the management of its funds, including mergers and acquisitions and management personnel changes.
Like Skandia, Russell's annual manager turnover is around 10%. However, Russell does not issue press releases when it makes sub-advisor changes, Stark said.
Russell wants to establish a high level of confidence with its sub-advisors and publicizing any issue it may have with a manager would betray that confidence, he said.