The Point of Sub-Advising
July 27, 2012
A new report by research shop Cerulli Associates is sure to make a few subadvisors smile.
Total subadvisory assets will reach $3.3 trillion by year-end 2014, up from $2.8 trillion in 2011, Cerulli estimates. This represents 5.9% annual growth. The report also reveals that two-thirds of fund firms expect to increase their use of unaffiliated subadvisors.
Specifically, the report noted that alternative investment managers and non-U.S. strategies will be in an "optimal position" to secure new mandates. And, with broker-dealers allocating somewhere between 5% and 20% to alternatives in their models, Cerulli analysts recommend alternatives subadvisors "seek intelligence on each broker/dealer strategy and pursue accordingly."
Beyond alternatives, there are also opportunities to be had in other asset classes, such as equities, global tactical asset allocation, emerging markets, and nontraditional fixed income present for subadvisors.
And within the variable annuity space, there are "ample" opportunities for subadvisors. Why? Because VAs cost less to sell and is appealing for firms pursuing defined contribution shelf space, as many of the largest insurers are also active DC players, according to the report.
However, subadvisors do face challenges. Cerulli noted that consolidation among wirehouses has substantially increased the cost of distributing funds through this channel, leading independent and regional broker/dealers to follow suit. The standard in subadvisory agreements is for the fund firms to bear all distribution costs so the increasing cost of servicing the wirehous channel is eating into fund firms' margins.
As for challenges, there are, of course, terminations. Approximately 30% of terminations are due to poor performance on the part of the subadvisor. Another 25% are attributed to investment advisors opting to use an in-house team or a new affiliated manager. About 12% of the time, terminations are due to a strategy being shut down due to lack of demand.
"Subadvisory [work] is primarily outsourced distribution, and firms should not subadvise for the sake of subadvising," cautioned John Hsu, senior analyst and co-author of this report. "It is important that firms avoid any cannibalization of higher margin products and be judicious in selecting subadvisory opportunities."