One of the most positive trends among mutual fund investors in recent years has been their increased attention to diversification and asset allocation.
As a result, asset classes that once attracted only the most sophisticated and aggressive investors, such as international and domestic small- and midsize company funds, have found their way into the mainstream investor's portfolio, providing a way to enhance returns and achieve more diversification.
Keeping up with investor demand for variety can be difficult for banks that lack the resources to manage more specialized areas of investing. Nevertheless, offering a wide range of investment choices has become a strategic necessity in order to remain competitive.
Some banks have opted to make substantial investments in personnel to bring these capabilities in-house. But others have recognized that retaining experienced subadvisers can be much more cost-effective.
Banks that offer significant diversification options often have an edge in attracting and retaining assets. Individuals who want to add more specialized funds to their portfolio can look to a single source for their investment needs. By consolidating their assets, customers can manage their money more efficiently and conveniently.
In turn, banks benefit by capturing more of their customers' assets. Furthermore, as market opportunities change, individuals faced with a wide selection of funds are more likely to pursue these opportunities within their bank's fund family. From the bank's perspective, it helps prevent customers from taking their money elsewhere.
Among all asset classes, equity funds have drawn the largest share of cash flow in recent years. Within the equity category, international and domestic small-company funds have garnered significant assets. International and global funds, for example, have grown more than fivefold since 1991 and now total $200 billion, according to the Investment Company Institute.
Banks have consistently lagged the nonbank competition in providing these types of funds, which are widely viewed as future growth areas of the industry.
One reason may the expense; launching and managing funds in more specialized areas of investing can entail tremendous costs. To offer international funds, for instance, banks must attract and hire investment professionals, including portfolio managers, analysts, traders and fund accountants, who have expertise in foreign markets. Building a research structure can be especially daunting.
International investing - especially in emerging markets - requires analysts who are familiar with a country's market conditions, economic and political climate, and accounting methods (or lack thereof). A seasoned research staff can take years to develop and is costly to maintain.
Building an investment infrastructure to support research on domestic small or midsize companies is also a costly undertaking, but is necessary to gain a performance advantage. Smaller companies receive very little or no coverage from Wall Street, so analysts supporting small-company mutual funds often spend a great deal of time meeting with managements to assess company prospects. In other words, rigorous fundamental analysis is especially critical in this area.
The high cost of managing specialty funds has caused many banks to turn to experienced subadvisers. By outsourcing, banks leapfrog the development process and eliminate the significant startup costs and time associated with building a credible investment team. As a result, they can bring their funds to the market faster.
For example, Griffin Financial Services, a wholly owned subsidiary of H.F. Ahmanson & Co., one of the nation's largest thrifts, introduced the Griffin Portfolio Builder, a mutual fund wrap account that allows customers to allocate investments among their proprietary family of mutual funds. In order to build their fund family rapidly and efficiently, Griffin Financial Investment Advisers (an affiliate of Griffin Financial Services), uses subadvisers with specific expertise and name recognition for all their proprietary funds.
Choosing a subadviser should not be a leap of faith. Banks should retain only those with significant subadvisory experience, records of consistent long-term performance, and compatible culture and investment philosophies.
But the services of properly chosen subadvisers can free banks to concentrate resources and expertise where they can add the most value - on business development across their broad customer base.
Mr. van Wagenberg is a vice president in the financial institutions division of T. Rowe Price, a Baltimore-based investment management firm.
