European markets revel in sub-advisory growth

There is no doubt that the European sub-advisory market is growing and the positive trend is set to continue during 2006/2007. This is the final verdict given by 77 per cent of respondents in PWM’s third annual survey. The increasing need for asset managers to focus on core competency is the key market driver, which is indicated, according to the interviewees, by the current trend to separation of manufacturing and distribution of investment products. It is fuelled by the opportunity to broaden their product range, which has been offered by Ucits III legislation.

With the opening of frontiers and globalisation of services, client demand is expected to shift towards gradually more sophisticated products, which will lead to increasing competition among asset managers. In order to deliver good performance, efficient products and increased speed to the market, the only recipe for survival for the generalist will be to delegate the asset management of niche products to specialist boutiques.

Lukas Frey, head of product management and development at Julius Baer, says: “The trend to more complex and sophisticated product concepts will push sub-advisory outsourcing for niche markets or for products which require very specific know-how and capabilities. Therefore, a further split of the value chain is foreseeable”. However, he says that there is a trend away from outsourcing in core markets and plain vanilla products, where in-house management is preferred and pushed.

A substantial number of respondents cited multi-management as a growing area. Chris Arnott, investment director at Standard Life Investments, says: “There will be a continued shift towards manager of managers rather than fund of funds mandates, except in certain asset classes where the latter has advantages or can be better delivered ie hedge funds and private equity. This will in part be due to greater cost transparency. Clients will start to better understand the range of multi-manager approaches being taken within the marketplace, such as global tactical asset allocation with macro bias or beta orientation, blending for alpha (stock bias)”. In 2004, Standard Life introduced a multi-manager structure, currently overseeing ?560m, run in conjunction with Wilshire.

Some of the interviewees, however, thought that multimanagement activity implemented through buying funds – which does not fall within the PWM definition of sub-advisory – or more general third-party distribution could actually hinder the fast growth of the sub-advisory business. Furio Pietribiasi, general manager at Mediolanum, says: “In the retail arena, in Italy and Europe in general, the growth for sub-advisory will marginally increase, just for new innovative products, where in-house capabilities don’t exist. The real growth is expected to happen on third party funds distribution. Indication of this could be the evidence of the disengagement of biggest banks from asset management business such as Banca Intesa, Sanpaolo, Deutsche Bank, Citigroup, etc.”

What sub-advisers are used for

Over two-thirds of the institutions in our survey admitted that the rationale behind sub-advisory delegation lies in the need to complete their funds range, when they don’t have in-house capabilities. Over half of those institutions delegating mandates employ sub-advisers because they believe in a multi-manager approach. The ultimate aim for using sub-advisers is to meet client demand for an enhanced product range, according to 36 per cent of respondents.

Assets outsourced and sub-advisory models

As also emerged in last year’s survey, European institutions typically award sub-advisory equity mandates. Italian players, however, look for dedicated sub-advisers to manage their fixed income segment too (see chart 1). Standard fund management delegation is the most used model by European institutions.

Multi-management, using sub-advisers and not simply distributing third-party funds, is stronger in France, where it is employed as much as fund delegation. Excellent examples are provided by Louvre Gestion, part of the HSBC Group, which employs 25 external managers on a sub-advisory basis for managing both equities and bonds. FundQuest, which supervises sub-advisory business for the BNP Paribas group, employs 10 managers, mainly for equities, on a white-labelled basis within Parvest, the Luxembourg-based open-ended Sicav fund marketed by the group.

Also in the UK, the survey’s results show that multi-management is the most popular sub-advisory model (see chart 2).

Size of assets outsourced

Our respondents, who between them manage around ?3870bn, have seen the size of their outsourced assets increase by 19 per cent over the last 12 months. Mainly due to market growth, their assets under management (AUM) have increased too during 2005, by 28 per cent on average. The net result is a slight reduction of assets outsourced as percentage of AUM.

“There will be a continued shift towards manager of managers rather than fund of funds mandates” - Chris Arnott, Standard Life Investments

The Italian institutions in our survey, who between them manage assets worth ?710bn, delegated the management of ?64bn, equivalent to 9 per cent of total assets. Half of the Italian institutions estimated that the Italian market in sub-advised mandates is currently worth only up to ?50bn. This is clearly an underestimate, in view of the survey results. The remaining half of the Italians estimated that the market size could range from ?75bn to up to ?200bn.

The French institutions estimated that the size of their national sub-advisory market could range from less than ?25bn to ?150bn, with no evident consensus. The French respondents have AUM worth more than ?1000bn, of which only ?15bn is outsourced.

The UK institutions surveyed, who manage ?1270bn, enjoy Europe’s most mature market for sub-advisory delegation of asset management. More than 11 per cent of their total assets are outsourced, totalling ?143bn. Accordingly, their estimates for the market are higher, and a few of them ventured to say sub-advisory business could be worth more than ?300bn.

The Spanish sub-advisory market is worth less than ?25bn, according to the vast majority of the Spanish respondents. Less than 0.5 per cent of the total AUM (?249bn) are outsourced, a total of just ?719m.

A huge majority (67 per cent) of institutions surveyed expect the size of their outsourced assets to increase going forward. But the percentage goes up to 80 among those who already outsource (see chart 3).

When probed about their positive expectations, 37 per cent said that the increase will be due to new products being launched and outsourced, while 61 per cent expects continued market growth and positive inflows into existing outsourced outsourced (see chart 4).

Most used/highly rated sub-advisers

Schroders, Merill Lynch and Goldman Sachs were among the sub-advisers most frequently used by our respondents. Pimco, Russell, Axa Rosenberg, Western and Barclays were also popular choices. The most highly rated were Goldman Sachs Asset Management, followed by Pimco, JP Morgan, Schroders, Invesco and Merrill Lynch (see Chart 5).

Selection criteria

The largest majority of the decision-makers in our survey (69 per cent) rated “long term consistent fund performance” as “very important”, the top score, when selecting a sub-adviser. Management team and specialisation of the manager trailed behind with 49 and 44 per cent respectively. Also “very important” is top quartile fund performance for 38 per cent of respondents and investment style for 33 per cent of them (see chart 6).

But how do decision-makers of private banks and fund houses identify best of breed managers? Again, fund performance tops the rankings, while none of the respondents saw the size of AuM as the most important factor for measuring the level of a manager’s specialisation.

Use of consultants

Selection of external managers still falls within the competence of in-house senior management exclusively. Only 24 per cent of respondent have used consultants to select external managers. The large majority (91 per cent) of those who have not used them in the past, have no intention to employ them in the future either.

Impact of recent pan-European regulations

According to 42 per cent of our respondents, recent pan-European regulations are expected to have a significant impact in the choice of assets that can be included in a sub-advisory mandate. Three-quarters of the French, and half of the Spanish, Italian and UK institutions believe that the broader range of investment instruments allowed by new legislation, such as Ucits III, will encourage them to outsource new specialist asset classes (see chart 7).

Cash plus/absolute return, unconstrained fixed income, asset allocation and hedge funds are the products that will be launched by the highest percentage of respondents. Twelve per cent of respondents plan to outsource their cash plus/absolute return and hedge funds, while over 20 per cent will buy third-party funds. Commodity and currency will also be the products for which a good percentage of institutions will buy third-party funds.

The impact of new legislation will vary from country to country. A quarter of the French institutions plan to outsource/sub-advise commodity and hedge funds, around 30 per cent of the Italians plan to delegate the management of cash plus/absolute return while a third of the Spanish will award hedge fund mandates.

“The trend to more complex and sophisticated product concepts will push sub-advisory outsourcing” - Lukas Frey, Julius Baer