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State Street Capitalizes on Growth in Sub-Advisory Business

Mike McNabb is the director of State Street Global Advisors of Boston's institutional sub-advisory group, which offers a variety of unique sub-advisory services, such as interim management.

McNabb discussed recent trends in the sub-advisory business with Mutual Fund Market News' Andrew Brent. An edited version of their conversation follows.

MFMN: A recent survey by the Financial Reporting Council indicated that nearly 11% of all mutual fund portfolios are sub-advised. Has the business grown at your own firm, and if so, what do you think are some of the reasons for that?

McNabb: There has been a tremendous amount of growth. I think there are two driving forces resulting in the growing interest on the part of mutual fund companies to hire external managers. The first is, while fund complexes are trying to build long-term relationships with their clients, we have all suffered through a long period of bad performance. It's very difficult to have a top-decile manager and have that manager maintain that position over extended periods of time. These are very, very challenging times; the capital markets are increasingly difficult.

So, some firms are finding it is easier to sub-advise a fund out to a highly performing manager, or even to use the sub-advisory arrangement to put an arm's length distance between themselves and bad performance.

The other thing is that the market is demanding new and innovative products and they want them immediately. For most mutual fund complexes it's very difficult to create products as quickly as the market is demanding them. The cost of research, development and marketing is increasing tremendously. Are you going to spend your budget on the origination and marketing of new products, or are you going to spend it on the investment side?

Many fund companies are finding it is more expedient to find partners that leverage their core capabilities. For a tremendous amount of mutual fund companies, their core capability is distribution, and they're very willing to talk to firms, like SSgA, for these types of sub-advisory relationships.

MFMN: In addition to the asset retention benefits of sub-advisory relationships, is there a direct marketing advantage in hiring a well-known investment manager? Do any of SSgA's clients, for instance, promote the fact that their funds are managed by SSgA?

McNabb: Yes, there are advantages to hiring a well-known manager, but it varies. Everyone's business model is different. Everybody's core competency is different. Everybody's branding value is different. Some of our clients originate the assets in the retirement market. In that market, they are very comfortable talking about SSgA as a sub-advisor because we're very fortunate to be the largest manager of retirement assets in the country. That labeling and association brings value to their story. In other instances we have mutual fund complexes that may be associated with a wirehouse, where their brand is very strong and it's not necessary for them to leverage our strength as one of the largest money managers out there. It really becomes a business issue.

MFMN: With $15 billion in sub-advised assets, where does SSgA rank within the sub-advisory marketplace?

McNabb: We define the investment management market as asset gatherers, a term we've coined to encompass mutual fund companies, insurance companies, recordkeepers and banks. That's anyone who is in the business of originating and retaining assets. Most of the research out there is being done in two categories, either insurance companies, specifically variable annuities, or mutual funds. If you were to take a look at the category of just mutual funds, we probably rank eighth or ninth, but I expect we'll grow pretty dramatically over the next couple of years.

MFMN: How do you expect to grow? Specifically, how do you market your sub-advisory services to potential mutual fund clients?

McNabb: We created a business group a year and a half ago, called the institutional sub-advisory service group, which I head here. It focuses on the retirement market and not-for-profit market, which includes foundations and endowments.

That group contains sales, marketing, client service, operational support as well as access to a group we call the advanced research center, which is a problem-solving group of academics and investment professionals who we bring to our clients. These various teams address all of the components of a client relationship.

MFMN: How big is your group and how many clients do you serve?

McNabb: Right now, the institutional sub-advisory group is comprised of seven people. The individuals who work for me have various backgrounds, ranging from mutual fund investment management, to operations, to compliance, to client service.

We serve 49 clients today. In terms of our revenue growth, we expect more than 30% revenue growth over the next several years.

MFMN: Do you ever approach potential clients that have not yet indicated that they are seeking a sub-advisor?