The Rise of the Sub-Advisor

The sub-advisor relationship in the US investment sector is not new; in fact, the concept has been around for over 60 years. However, it has gained widespread popularity in recent years as investors have become more comfortable with the idea of outsourcing investment management to specialists.

So too have the SEC's rules around the use of sub-advisors changed in recent years, making it easier for registered investment advisers to outsource some or all of the investment management function to sub-advisors.

The rule change happened in 2009, when the SEC adopted Rule 202(a)(11)-1 under the Investment Advisers Act of 1940. Prior to that, advisers were generally prohibited from outsourcing more than 25 percent of their assets under management to sub-advisors. The new rule permits advisers to outsource up to 100 percent of their assets to sub-advisors, so long as the adviser maintains ultimate responsibility for supervising the sub-advisor and complying with the Advisers Act.

Further SEC rule updates in August 2023 state that a registered investment adviser that serves as a sub-advisor to a Private Fund with a third-party manager has certain obligations with regards to:

• Quarterly Statements. A sub-advisor must prepare and distribute quarterly statements to Private Fund investors if the primary adviser does not distribute quarterly statements.
• Audits. A sub-advisor must take “all reasonable steps” to ensure that the Private Fund undergoes an audit and distributes audited financial statements. 

Launching new funds

In some cases, investment managers can launch new fund offerings more efficiently with lower costs and better operational processing through a sub-advisory relationship. Under this arrangement, the investment manager entrusts day-to-day management of the fund to another firm with greater operational capabilities. The sub-advisor is paid a fee for its services, and the investment manager retains ultimate responsibility for the fund’s performance.

Free up time

Sub-advisory arrangements allow investment managers to focus on core competencies, such as investment research and portfolio management, while delegating operational responsibilities to a sub-advisor. This can enable investment managers to scale more effectively. In addition, sub-advisory relationships can provide access to a larger pool of potential investors and help build brand awareness.

For sub-advisors, these relationships can offer an opportunity to broaden their product offerings and expand their reach in the marketplace. In some cases, sub-advisors may be able to leverage their scale and operational capabilities to offer lower fees than the investment manager.

Growth in the sub-advisory market

Sub-advisory relationships are a win-win arrangements for both investment managers and sub-advisors which is probably why the sub-advisor market has grown from $1.5 trillion in assets under management (AUM) in 2003 to an estimated $4 trillion in AUM according to Cerulli Associates. This growth can be attributable to the increased focus on fee compression and the need for advisors to outsource specific investment strategies to specialists.

A high number of advisors now use sub-advisors, it is estimated around 80% of advisors outsource to sub-advisors in some capacity and this figure increases as the firm size increases.

Maintaining sufficient oversight is key

The SEC states that advisers must disclose their use of sub-advisors in their Form ADV, and must provide details about the nature of their supervisory arrangements with sub-advisors.

Advisors must now take a more proactive role in ensuring that each sub-advisor is meeting its fiduciary obligations and adhering to the investment strategies outlined in the client's investment policy statement. This increased scrutiny may place a greater burden on advisors, but it ultimately protects investors and helps to ensure that their assets are being managed in a safe and responsible manner.

Sub-advisors should be carefully vetted initially to ensure they have the experience and expertise to manage the fund in a manner consistent with the investment manager's objectives. In addition, investment managers need to monitor the ongoing performance of the sub-advisor on an ongoing basis to ensure that the relationship is meeting expectations.

How does Dasseti de-risk the sub-advisory relationship?

Dasseti provides a due diligence and monitoring platform for advisors and investment managers to maintain close oversight of sub-advisors. The secure, digital platform automates data requests and flags and scores responses for easy comparison and risk management. The platform provides a full audit trail and allows managers to meet compliance mandates around the use of third parties.

Get in touch to request a demo of Dasseti Collect and we will show you how it can transform sub-advisor monitoring.