Despite high-profile shifts, fund sub-advisors hold steady

(May 12, 2003) Mutual fund manufacturers moved more fund management in-house and cut their ties to sub-advisors in 2002. It’s not just mutual fund managers who are seeking more control of asset management. Segregated funds operated by the insurance companies are following the same route. Despite the dip, however, sub-advisors are holding their ground, in terms both of assets and fund performance, a new study says.

The April issue Insight, published by Toronto financial services consultancy Investor Economics, suggests three reasons for the decline in third-party management in 2002. Partly it’s a matter trying to maximize profits, but it also reflects a desire to trim exposure to manager departures, like the high-profile separation of Brandes and AGF. In addition, mergers among fund manufacturers have resulted in a rationalization of funds, resulting in fewer managers. (Click here to read an interview with one of AGF’s sub-advisors, Harris Associates partner Edward Loeb.)

External advisors managed more than 18% of mutual fund assets in 2002, or $62 million. That’s down from 20% in 2001. Despite last year’s dip in market share — over the past eight years, externally managed assets have ranged from 16.6% to 22.4% of assets — sub-advisors are not wanting for business, Insight says. Assets under management and market share are higher than they were throughout most of the 1990s. CI, TD, AGF, AIM and Manulife have all moved assets in-house, but some smaller companies, such as Clarington, have “successfully built a solid fund business with a strategy of predominantly using external sub-advisors.”

While some of the largest fund manufacturers eschew external advisors, smaller companies like Ethical, Clarington and IPC’s Counsel Wealth Management do rely on them. Other companies, like Investors Group, turn to sub-advisors for specialized expertise, Insight notes. There were nine new sub-advisors last year, including Harris Associates, which AGF picked to run its international value fund after Brandes walked away. At the same time, the CI takeover of Sun Life’s mutual fund business resulted in a number of departures. In all, 14 sub-advisors were let go in 2002.

Return to normalcy

In some ways, 2002 was a return to normalcy, Insight suggests. By contrast, 2001 was a year of dramatic change, as some companies used sub-advisors to bolster their offerings. Cartier and IPC both aggressively expanded their lineup in 2001.

While they didn’t expand as much as in 2001, by no means did sub-advisors simply contract in 2002. CI, for example, added Legg Mason to its fund lineup in a high-profile offering and retained former Spectrum advisor Sionna Investment Managers, which Investor Economics characterizes as an in-house manager like Webb Capital and BPI, rather than an external manager. Also, Sceptre brought in a number of funds advised by its strategic partner, Putnam Investments. Year over year, 2002 saw the replacement of 30 sub-advisors, the addition of 7, and switches between 12, including AGF’s shift from Brandes Investment Partners to Harris Associates.

Who is who? Largest sub-advisors to Canadian mutual funds industry Sub-advisor firms ranked by December 2002 long-term fund assets in billions of dollars
Rank	Sub-advisor firm and number of fund companies sub-advised to	List of fund companies sub-advised to	Dec. 2002 assets	Yr/yr growth
1	Harris Associates L.P. (1)	AGF	6.1	—
2	Franklin Templeton (4)	Elliott & Page, Investors Group, Mackenzie, MD	3.5	-18.5%
3	Jarislowsky Fraser & Co. (5)	TD,MD, CM Investment, Evolution, Cartier	2.9	3.3%
4	Beutel Goodman & Co. (5)	Cartier, Investors, Mackenzie, Clarington, Opus 2 Financial	2.7	-3.1%
5	Connor, Clark & Lunn (4)	AGF, Ethical Funds, MD	2.5	-19.8%
6	Seamark Asset Mgmt. (2)	Elliott & Page, Clarington	2.3	23.0%
7	Barclays Global Investors (2)	AGF, Dejardins	2.1	-26.1%
8	AGF (5)	Investors Group, CI, Mackenzie, BMO, Optima Strategy	2.0	28.9%
9	YMG Capital Mgmt.(1)	Investors Group	1.8	-26.0%
10	Equinox Capital Mgmt. (1)	MD	1.6	—
Source: Investor Economics, Insight, April 2003

The biggest sub-advisor, measured by assets, is Harris Associates, with $6.5 billion, nearly twice the assets managed by the next largest sub-advisor, Franklin Templeton. Rounding out the top-five are Jarislowsky Fraser, Beutel Goodman and Connor, Clark & Lunn. In all, there are 177 companies providing sub-advisory services, down from 183 in 2001, but up from 153 in 2000. They manage well over 600 mutual funds.

In a recent survey by Benefits Canada Jarislowsky Fraser was tagged as the fastest growing pension manager in dollar volume, with assets growing 37% in 2002. It is also the number-five pension manager in Canada, following the Quebec giant CDP Capital, TD Asset Management, Phillips Hager & North and Barclays Global Investors. On that list, Franklin Templeton ranks 24, Beutel Goodman 15 and Connor Clark & Lunn 13.

Bear market opportunities

Insight predicts more sub-advisor changes in a constrained, cost-cutting bear market environment, but adds that there is “ample opportunity for those sub-advisors who are nimble enough to beat their peers, especially if they can offer a cost-effective alternative to in-house management.”

Using Morningstar rankings, Insight finds that in-house funds and sub-advised funds are more or less evenly matched. To add more discernment, Investor Economics created two hypothetical portfolios of in-house and sub-advised funds, using international specialty and equity, Canadian multi-capitalization and small-cap, and U.S. equity and Canadian income trust funds. Sub-advised funds outperformed over three and five years, mostly because of strong results in the international specialty category. Stripping that category out, Investor Economics found that sub-advised funds underperformed over three years, but outperformed over five. “The bottom line,” says Insight is that “there is no clear-cut evidence that either management structure is consistently superior.”

While sub-advised funds tend to be more expensive, this is not true in the Canadian large- and mid-cap equity categories. Also, Insight reports, more than half the money in Canadian large-cap funds is now managed by sub-advisors. Sub-advisors, in addition, account for 29% of U.S. equity fund assets and 25% of international equity fund assets. When counted by the number of funds managed, the sub-advisor share is even larger, although those funds tend to have smaller asset bases.

Says Insight, “this is another indicator of the cross-currents in which larger companies are moving money in-house while smaller companies are placing more assets with sub-advisors.”

Among the large fund companies, AGF relies most heavily on sub-advisors, who account for 49% of assets under management. Smaller manufacturers have a heavier dependence, with Counsel, Northwest, Ethical and Clarington relying almost entirely on sub-advisors.

However, in the segregated fund market, AGF is the biggest sub-advisor, followed by Mackenzie, John Hancock and YMG Capital Management.

Filed by Scot Blythe, Advisor.ca, sblythe@advisor.ca.

(05/12/03)