Fund sub-advisors fight over shrinking market

By Steven Lamb | July 28, 2004 | Last updated on July 28, 2004
3 min read

(July 28, 2004) While their asset base has grown steadily throughout the market recovery, competition between mutual fund sub-advisors has become fierce, as fund companies seek to cut costs and move management in-house, according to a report from industry analysis group, Investor Economics.

“Sub-advisory firms face ever tougher competition from their peers as the number of funds slips and the number of advisory firms grows, and as the trend toward vertical integration creates more impetus for sponsors to move more of their portfolio management in-house,” states the July edition of Investor Economics Insight.

But despite the trend toward in-house management, the size of assets managed by external fund advisors is growing steadily.

While the market share held by sub-advisors dropped to 17.7% of assets by the end of May 2004 from 21.5% in 2001, a large part of this drop can be accounted for by the bursting of the tech bubble and the decision of Brandes Partners to leave AGF and become the in-house advisors for their own Canadian fund firm.

“The actual asset base is still sizeable, and there is keen competition for those dollars as money management firms battle each other for mandates in the same sort of takeaway game that occupied mutual fund companies for so many years,” reads the report. “As a result, nimble players continue to enjoy abundant opportunity.”

But since the dramatic market declines of 2001, the size of the sub-advisory pie has shrunk while the number of management firms has increased.

As fund manufacturers merged funds and generally rationalized their product line, the number of externally managed funds dropped to 585 by May of this year from 704 in 2001. In the meantime, the number of firms offering external management services has started to creep back up and at 171, is only 12 shy of the 2001 high of 183.

External sub-advisors still play a major role in key sectors of the mutual fund industry, accounting for 37% of the U.S. equity funds available in Canada, and 30% of the international equity funds. The percentage of asset base in these areas is somewhat lower, however, representing 29% and 23%, respectively.

But one of the key reasons sub-advisors became so popular during the bull market has faded, as the performance of fund managed by “star” subs declined. In fact, they now seem to lag the in-house managers.

As a group, 28% of externally managed funds earned four- and five-star ratings from Morningstar Canada in May of 2004. But in-house management fared even better, with 32% earning the high ratings, indicating outsourcing is no guarantee of superior performance.

And with leaner returns of the bear market still lingering in investors’ minds, competitive emphasis has been placed on lower management fees, rather than star managers. Again this favours taking fund management in-house as the manufacturer can remove one level of cost or fatten their own margins.

“Vertical integration supports moving money management in-house, as does the new gospel of cost control,” says the report. “Growth prospects for individual firms will no doubt depend on their ability to generate consistent returns at reasonable cost.”

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Steven Lamb