Decisions about how much to delegate

‘If you are a bank in Europe it would be perfectly reasonable for

you to tell your clients that even though you don’t manage Japanese

equities yourself you will however pick up the best manager at doing

that’

Alex Fletcher, Goldman Sachs

There are different reasons why a bank or insurance company might

decide to choose external sub-advisers when it comes to asset

management, but they are mostly related to cost-efficiency and the need

for enhanced investment returns.

Recent disappointing results have made it clear to chief executives

that some business models they followed in the past do not necessarily

work in the current environment. The need to prioritise and concentrate

on core competencies is being translated into the search for external

expertise.

On the other hand, investors are becoming more demanding, expecting

their banks to offer them the widest range of investments available,

making it necessary for companies to look outside for solutions that

complement their in-house capabilities.

Reasons to go external

According to Alex Fletcher, managing director of Goldman Sachs Asset

Management International, there are different situations that can lead

a bank to adopt a sub-advisory model.

“A bank might decide to sub-advise because they want to focus only on

distribution, and investment management is not their core activity any

more,” says Mr Fletcher. “To be good at investment management you need

a lot of resources and a lot of hard work. You might be getting results

that are not good enough, or maybe they are but you are just being

lucky, and you realise that potentially it could very expensive for you

to get it wrong.”

This could lead to the decision to outsource the whole asset management

capability and award sub-advisory mandates to external providers. “It

is a tough decision to make and you need a chief executive who is

really determined to only focus on the things the bank is really good

at,” he adds. “However, there is nothing like a bear market for two or

three years to make people think about their cost and what they do

well.”

When to start looking

Another reason to start the search for a sub-adviser, and perhaps an

easier decision to make, is when a bank decides to concentrate on a

particular type of investment.

It would be quite normal for a European bank, for instance, to decide

to focus on just European equities and European bonds. “If you are a

bank in Europe it would be perfectly reasonable for you to tell your

clients that even though you don’t manage Japanese equities yourself

you will however pick up the best manager at doing that,” Mr Fletcher

says. “This we can call ‘range completion’. It’s a very common reason

to decide to sub-advise a specific asset class.”

For others who believe in the principle behind open architecture in

fund management, that says you can make your whole business bigger by

offering more than just your own asset management to your increasingly

demanding clientele, sub-advisory arrangements can be a solution.

“They don’t really want to see another asset manager’s name closely

identified with their client and they think it would be better to offer

their own branded product, but managed by someone else,” says Mr

Fletcher.

Sub-advisory models

Once the decision to outsource has been taken, banks must choose the

sub-advisory model they wish to follow. Defining the types of

sub-advisory arrangements currently available is not an easy task. We

will concentrate on the five more common models as explained by Mr

Fletcher:

Delegation of fund management

The first, and probably simplest, option is when a bank that has a

mutual fund or a life insurance fund decides to delegate the management

of the fund to someone else. “This is the most common type of

sub-advisory, when a bank decides to outsource the management of a fund

to an external asset management company. In this case, the prospectus

of the fund will show who the sub-adviser is,” says Mr Fletcher.

A good example of this would be a bank that decides to give the

management of a Japan equity fund to someone who is good at managing

this asset class, instead having an internal portfolio management team

based there.

Multi-management arrangements

Another type of sub-advisory is when a company decides to offer

multi-manager funds to their clients. “They might decide to pick three

good Japanese equity managers, for instance, and blend them together

into one fund,” says Mr Fletcher. He explains that from the

sub-adviser’s point of view, this model doesn’t differ from the first

one, since in both cases they are given a mandate to manage a

particular asset class. However, the client will have not just one but

three sub-advisory agreements with three different asset managers.

White labelling

A third and more different approach is what is called white labelling

of funds. In this case, the bank decides that rather than setting up

their own vehicle and outsourcing its management to a third party asset

manager, they prefer to choose a fund offered by a sub-adviser, and

brand it under the bank’s own name.

“This model is different from the two others because in this case we

are talking about a fund of our own and we are responsible for the

legal vehicle, as opposed to just managing the money,” says Mr Fletcher.

Currency overlay

A more technical approach to sub-advisory is that related to the

outsourcing of currency management. As an example, we could think of a

bank that has a balanced fund and knows how they are going to split

their portfolio into equities and bonds, and which types of investments

they are going to be looking at, but they don’t want to decide which

currencies they should be invested in.

“If they believe that someone else could make good decisions about

currencies that can add return to the overall portfolio, they might

decide they want to outsource just the currency management of the

portfolio and manage the rest in-house,” comments Mr Fletcher. “In this

case, the sub-adviser will only have responsibility to manage this

specific part of the portfolio.”

Model portfolio

In some countries banks are not allowed to delegate the management to

third parties. When this is the case, and the bank still feels the use

of external expertise is crucial for the management of a particular

asset class, they can ask a sub-adviser to provide them with a model

portfolio, which they could then follow.

“The actual management of the fund in this case is done by the bank

itself, but based on a model portfolio provided by an external asset

manager,” he says. “This is not something that we do, because our job

is about having full discretion of the assets and working closely with

the custodian, but it’s a model which is quite prevalent in certain

parts of Europe, like Denmark for example.”

How to choose

When it comes to choosing a sub-advisory model there are no general rules.

It cannot be said than one particular model is more efficient than the other because it all depends on the client’s needs.

“In the ideal situation we would initiate the conversation with the

client and then, jointly, we would figure out what the best approach

is,” Mr Fletcher points out. “However, quite often, they already know

the route they want to take and we take it from there.”

In terms of choosing a provider, the criteria banks take into account

differ depending on the arrangements they want to make. “If you are a

chief executive making the decision to outsource your whole business,

you are going to want to link with someone that on the one hand is a

reasonably well-known name but also has a reputable investment process.”

He continues: “Probably you don’t want to pick someone that is in

direct competition with you. If you are a German bank, for instance, it

would be an odd decision to choose a German asset manager to outsource

your fund management business to.”

However, if a bank is choosing a sub-adviser only to complete their

product range, it would be more likely to see small boutiques on the

shortlist. In these cases, banks would be probably less concerned about

the brand name and focus mostly on who is best in that particular asset

class.

“Finally in the multi-management space, or in the open architecture

arena where you put your own brand on it, most are choosing the

well-known names,” Mr Fletcher adds.

Ability to interact

But one thing that most banks seem to take into account to a lesser

or greater extent, when choosing a sub-adviser, is their ability to

interact with their organisation.

Because in many cases the relationship is very close, the sub-adviser

becomes something like the investment division of the bank and at this

point interaction is crucial. Client service, training and marketing

materials are key to keep the relationship working.

“When you build a strong relationship with the person you are managing

money for it could become a very long and fruitful relationship for

both parties.”

Mr Fletcher believes the sector will continue growing over the next few years all across Europe.

“The more the banks think about their profitability and what they are

good at, the more they will focus on their core strengths.

“A series of rough markets have made their asset management business

less profitable and they question whether this is an activity they want

to be in.”

SUB-ADVISORY MODELS IN BRIEF

Fund Management Delegation

A bank decides to delegate the management of a fund to an external asset manager

Multi-management

A bank decides to offer a fund managed by more than one sub-adviser

White labelling

A bank chooses a fund from a sub-adviser and brands it under their own name

Currency Overlay

A bank delegates the currency management of a fund to a sub-adviser

Model Portfolio

A bank manages one of its funds following a model portfolio provided by a sub-adviser

Source: PWM/GSAM