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Sub-Advisory Business Tougher for Small-Caps

When the Quintara Funds of Piedmont, Calif., officially launches its flagship Quintara Small Cap Value Fund on March 1, the fund will be lacking one of the well-known and highly regarded small-cap managers it had selected to help sub-advise the fund.

Wasatch Advisors, the Salt Lake City investment manager with $5.6 billion in assets under management had been selected as one of four sub-advisors to manage a portion of both the new fund and the soon-to-be released Quintara Small Cap Growth Fund.

But in a situation that highlights the challenges of running small-cap funds, Wasatch recently decided to back out of the deal because of concerns for its own stable of small-cap products, said Eric Bergeson, director of marketing at Wasatch. "We looked at the opportunity [with Quintara] and we thought we had the capacity at the time. But there were liquidity issues that were subsequently raised," Bergeson said. "You can't invest an infinite amount of money in a small-cap fund because you will either own too much in those companies you have invested in, or be forced to buy other, larger companies," he said.

The Quintara Funds, which had initially hoped to launch with five sub-advisors on each fund, eventually whittled that number down to four sub-advisors, each managing an equal 25% of assets.

But Wasatch's decision to back out of the sub-advisory deal reduced the funds' sub-advisors to three, with each sub-advisor expected to invest in between 12 and 18 stocks, said Quintara President Matthew Sadler.

Wasatch, which has carved out a niche for itself managing nondiversified no-load funds that invest predominantly in small- and micro-cap stocks, has so far closed four out of its five proprietary smaller cap funds to new investors.

Most recently, Wasatch pulled in the welcome mat to all existing investors of its sole micro cap fund on Jan. 31, 2002. At the same time, the firm closed the Wasatch Core Growth Fund to new investors and expects to close that fund to existing investors in the near future.

Last year Wasatch closed both its small-cap growth fund and its small-cap value fund. The Wasatch Ultra Growth Fund, the group's most aggressive small-cap growth fund, is its only small-cap offering still available to new investors.

Wasatch feared that investing for the Quintara funds in the same companies it held in its own proprietary fund, would produce higher ownership stakes in those companies, creating liquidity problems.

Wasatch closes its funds to new investors in order to protect its shareholders, said Bergeson. "We didn't feel it would be honest to close to new investors and say, but you can get the same thing over here at Quintara," he said.

Despite an increase in sub-advisory alliances, the capacity issue among small-cap fund managers persists. That is largely because the market environment has favored value-oriented stocks in the small-cap universe, said John Benvenuto, senior consultant with Financial Research Corp. "Capacity issues typically trump sub-advisory issues and lots of firms will have this issue," he said.

While other companies may struggle with the challenge of maxing out small-cap funds' assets while maintaining an ability to invest in small-cap stocks, Wasatch will only manage to a comfortable asset level, Bergeson said. "We are not an asset gathering company."

Wasatch's decision not to accept the new sub-advisory appointment flies in the face of the general fund industry trend toward more funds being sub-advised, for a variety of reasons. Amid slowing sales in their own proprietary products, many fund groups have been actively wooing other firms, hoping to snare a sub-advisory arrangement for themselves.

Delaware Investments, OppenheimerFunds and INVESCO Funds, to name three, have all been accelerating efforts to rustle up sub-advisory deals since 2000. Last month, Turner Investment Partners hired William Costin to market the Berwyn, Pa., fund group's mutual funds and its sub-advisory services.

According to FRC, approximately 11.8% of all fund assets were sub-advised at year-end 2001, almost double the 6.2% of all fund assets being managed by outside investment managers in 1991. Last year sub-advised assets grew to $465.6 billion, up 26.6% just since 1995.

Over the last 12 months, as many as 16 micro- or small-cap funds have closed their doors to new assets, according to Morningstar.