Cerulli: Fund of Funds Continue Asset Gain

The infusion of capital comes as assets in these funds depreciated 17% in 2002.   Worldwide, funds of funds hold $235 billion, down from $254 billion in 2001 but representing a three-year annualized growth rate of 16%. By contrast, the global fund industry shrank 3% per year during the same period, according to The Global Multimanager and Mutual Fund Subadvisory Markets 2003 report from Cerulli Associates.

Cerulli attributes the continued investment in fund of funds to embedded advice, affordable diversification, and access to foreign investments and managers.   Further, the international climate continues to look bright, as approximately $178 billion in fund-of-funds assets are domiciled outside the United States.   Over the trailing three years, these international assets have expanded at a compound annual growth rate of 18%. In 2002, two-thirds of net new fund of funds business came from international markets.

Best-of-Breed Waning

However, where in the past the more affluent market segments were utilizing funds of funds in lieu of true open architecture to seek the top tier in third-party management and for certain tax advantages, recently the fund of funds role in furthering open architecture has contracted.   Evidence of this is the plateau that open architecture within funds of funds hit in 2002. Unfettered funds of funds – those that invest in proprietary as well as third-party subfunds – represented 18.4% of fund-of-funds assets in 2002, the same proportion as in 2001.

This is due to existing multimanager programs meeting the demand for third-party best-of-breed management.   Due to the prolonged downturn seen in the markets over the past few years, manager selection has increasingly become a function of business and profitability issues. Therefore, in the resulting scramble for revenue, third-party asset manager selection – be it for multimanager programs, subadvisory services, or distribution – is strongly influenced by corporate relationships, reciprocal distribution, purchasing scale, rebates, fees, and service levels.

Manager-of-Managers

The economic concerns are further extended to a dropoff in demand due to outperformance no longer being highly visible in any market.   European distributors therefore are consolidating third-party asset management relationships among a handful of partners.   These distributors are seeking to:

• reach an optimal number of partners to give them access to a wide range of products while minimizing costs
• maximize economies of scale
• ensure the reciprocal distribution of their own funds into other markets and channels
• receive high levels of service.

The demand has led to retail manager-of-manager funds growing at a healthy clip in 2002.   In the non-United States market, these funds expanded more than 10%, bringing international totals in retail manager-of-managers assets to $40 billion in 2002 from $36 billion in 2001, with Australia and the United Kingdom representing the majority of net new business.   Not surprisingly, the funds appeared to be performing better than other multimanager products and services, including funds of funds. As a group, retail manager-of-managers funds lost only 10% of assets from performance during 2002.

The institutional market was not quite as promising, where manager-of-managers assets dropped to $89 billion in 2002 from $100 billion in the previous year, with only $5.4 billion in net new business flowing into institutional manager-of-managers mandates in 2002.