ERISA Plans Require Strong Subadvisory Due Diligence

Much of the growing use of multi-asset-class solutions occurs within corporate retirement plans and other types of institutions utilizing outsourced chief investment officer services.

New research from Cerulli Associates examines how investment managers looking to enter the business of subadvising must prepare for the rigorous due diligence involved.

While the findings are focused on asset managers and their business outlook, the results also should offer some insight to retirement plan professionals tasked with selecting and monitoring multi-asset-class mutual fund investments. The Cerulli analysis suggests, for example, that some asset managers struggle more than others with compliance in the institutional space—and that firms succeeding in either retail asset management or institutional management do not always transition smoothly into working with other types of clients/assets.

James Tamposi, research analyst at Cerulli, observes that the modern subadvisory due diligence process is “extremely thorough.” Asset managers that are excelling have “a clear investment philosophy and process, combined with adherence to a stated investment objective.” These factors are “paramount in winning business” from institutional investors, many of them hyper-concerned with compliance challenges. 

“When dealing with compliance, managers should view it as an opportunity rather than a cost,” he adds. “Especially in the subadvisory industry, effective compliance is an asset to the relationship.”

To that end, the analysis suggests due diligence processes implemented by institutional investors and the asset managers serving them will only grow more rigorous in the future—and this is a good thing. In the defined contribution and defined benefit world, a lot of the pressure has to do with the Department of Labor (DOL) fiduciary rule, along with the increased threat of investment-related litigation.

Research highlights shared by Cerulli suggest “many of the forces propelling the U.S. subadvisory market have existed for some time, but are coming to a head as asset managers perceive new opportunities.”

Notably, interest in multi-asset-class solutions is “drifting away from traditional balanced funds and global tactical asset allocation toward strategies with more specific objectives or absolute return investments.” Cerulli further finds “much of the growing use of multi-asset-class solutions occurs with corporate retirement plans and other types of institutions utilizing outsourced chief investment officer services.”

Also notable, according to Cerulli, is how the hedge fund-of-fund industry, “which has been under pressure from client withdrawals in recent years,” is trying to position itself within multi-asset-class mandates.

Cerulli concludes the shift away from commission-based accounts and the move to eliminate non-transparent layers of fees will encourage additional product providers to launch proprietary multi-subadvisor mutual funds. Investors and asset managers, in considering subadvisers, “will be more inclined to hire a manager with superior performance, but the manager also needs a clear investment philosophy, a consistent approach, and the ability to manage to the objective for which it was hired.”

These findings and more are from the July 2017 issue of The Cerulli Edge – U.S. Edition. Information about obtaining Cerulli research reports is available here