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Finding the right family
A year ago, Robert Turner, CEO and founder of Turner Investment Partners, stepped back and took stock of his $3 billion, 9-year-old money management operation.
At the same time, Turner, well known for his institutional small- and midcap growth funds, realized that the cost of building a distribution network for his growing mutual fund family would be prohibitive, running into the millions or even tens of millions of dollars.
As a result, in October 1999 Turner began discussions with Merrill Lynch & Co. and Vanguard Group, eventually transferring his two large-cap mutual funds to the distribution powerhouses. Turner in effect retired his name and signed on as a subadviser. Merrill and Vanguard rebranded the funds under their respective umbrellas, complete with Turner's five-star track records. The renamed funds were both officially rolled out in June. Turner's 11 other funds operate under his name exactly as before.
Turner's solution, industry analysts and executives agree, could change the way small and midsize money managers deliver their wares to the market. "We had the performance; they had the distribution," says Turner. "To re-create the kind of distribution Vanguard has within its 401(k) channels or Merrill with its sales force was unrealistic. So we turned the vehicles over."
Vanguard, for its part, happily bought Turner's past performance. "There's no way we could have just hired a subadviser and rolled out a fund with an eight-year track record," explains Vanguard's Joel Dickson, a principal in the Valley Forge, Pennsylvania-based firm's portfolio review group. With this agreement, "Turner now has a powerful distribution partner."
Adds Neil Bathon, president of Financial Research Corp., a Boston-based strategic consulting firm: "More and more companies are deciding that they can't go it alone when it comes to distribution. We expect this concept of swapping track record for distribution will gain momentum in the months ahead." FRC has in fact dubbed this process Turnerization and expects it to become the fourth major approach to obtaining distribution. The top three: doing it in-house, outsourcing the responsibilities to a third party and paying for it through supermarkets and broker-dealers.
Turner's distribution deal is already paying off. About $500 million has come into the firm's large-cap funds through the new alliances, roughly tripling their size. Meanwhile, Turner's 11 proprietary funds, including its staple small- and midcap funds, as well as its year-old Turner Technology Fund, garnered $500 million in new assets on their own. The added investment has put an exclamation mark on an extraordinary year for Turner, whose assets have more than quadrupled, to $12.5 billion (about 70 percent is institutional).
Never before has distribution been such a pressing issue for fund companies, in both the retail and institutional markets. A recent report, "Success in Investment Management," issued by Merrill and Barra Strategic Consulting Group, concludes that the current "open architecture" environment in financial services, in which firms sell both proprietary and nonproprietary products, will force firms to treat portfolio management and distribution as distinct enterprises. Only a handful will succeed on both fronts. "In the next generation," the report predicts, "investment manufacturing and distribution will no longer be able to cross-subsidize each other."
For fund companies the rising cost of third-party distribution (the average annual cost for firms with between $10 billion and $60 billion in assets was $60 million in 1998, according to FRC), as well as the requisite advertising expenses ($5 million a year, on average, for firms Turner's size) makes the Turner approach an attractive option for managers of highly rated but relatively obscure funds. And, says FRC consultant Thomas Tyson, "distributors realize they need better quality products."
Pete Moran, Turner's chief marketing officer, reports that three money managers have asked him to explain how Turner went about making its deals with Vanguard and Merrill. Almost certainly, more deals will follow.
"It's more complex than you might think," Moran says. "A lot of pieces need to fit. First, you need good performance - at least a three-year track record. Second, the asset class has to make sense for the distributor. And it has to make sense for the manufacturer. You wouldn't want to turn over your flagship product. We realized that we had two large-cap equity funds, not our main area of expertise, that were performing well but just weren't attracting many assets." Virtually all of the other Turner funds were growing on their own, with some closed to new investment and others approaching that point.
Analysts expect that firms with between $500 million and $5 billion in assets and at least five funds in their roster will benefit most directly from the Turner approach. "The trick is to find the one or two diamonds in the rough - funds with great track records but no assets," Moran says.
The Turner Large-Cap Growth fund, which Merrill renamed the Mercury Select Growth fund, reported an average annualized return of 41 percent between its February 1997 inception and June 30, 2000. That compares with a 27 percent average annual return for the Standard & Poor's 500 index during the same period. Meanwhile, the Turner Growth Equity fund, a portfolio that includes a wide selection of large-cap stocks and a smattering of midcaps, reemerged as the Vanguard Growth Equity fund. Between its launch in April 1992 and June 30 of this year, the fund reported an average annualized return of 23 percent, versus 19 percent for the S&P.
Though Turner will now collect about 60 basis points per dollar of assets as the subadviser, less than the full management fee of 75 basis points, he expects that the increased net asset growth will more than offset the short-term drop in revenues.
Merrill is very happy with its new relationship. "Large-cap isn't necessarily Turner's core competency, but the firm had an outstanding track record," says Mark Cone, president of Merrill's Mercury Funds. "For Turner, I would say letting us rebrand the fund borders on a brilliant move."
But the brokerage firm is not looking to duplicate the arrangement with another fund family any time soon, Cone says. The Turner alliance came as Merrill was making an effort to bolster its Mercury funds, making them more attractive to salespeople outside of Merrill. Adds Cone, "This was a one-time deal."
Vanguard, on the other hand, is constantly searching for sharp stock pickers. The fund company outsources approximately $140 billion of its $573 billion in assets to active equity managers. "We're always on the lookout for good managers," says Dickson, who helps oversee the two dozen active managers who serve as Vanguard's subadvisers.
"In the case of Turner, we were looking for a growth fund with a little bit more of an aggressive approach than our other offerings," Dickson says. "The fact that we were able to team up with such a well-regarded institutional manager with a demonstrated track record and one that was willing to turn the existing vehicle over to us, that was clearly a big benefit. But we are not going to hire someone just because we can get immediate access to a top-quartile track record. We have to have confidence in the people and the investment process."
Turner and his firm met both criteria.
As a result, in October 1999 Turner began discussions with Merrill Lynch & Co. and Vanguard Group, eventually transferring his two large-cap mutual funds to the distribution powerhouses. Turner in effect retired his name and signed on as a subadviser. Merrill and Vanguard rebranded the funds under their respective umbrellas, complete with Turner's five-star track records. The renamed funds were both officially rolled out in June. Turner's 11 other funds operate under his name exactly as before.
Turner's solution, industry analysts and executives agree, could change the way small and midsize money managers deliver their wares to the market. "We had the performance; they had the distribution," says Turner. "To re-create the kind of distribution Vanguard has within its 401(k) channels or Merrill with its sales force was unrealistic. So we turned the vehicles over."
Vanguard, for its part, happily bought Turner's past performance. "There's no way we could have just hired a subadviser and rolled out a fund with an eight-year track record," explains Vanguard's Joel Dickson, a principal in the Valley Forge, Pennsylvania-based firm's portfolio review group. With this agreement, "Turner now has a powerful distribution partner."
Adds Neil Bathon, president of Financial Research Corp., a Boston-based strategic consulting firm: "More and more companies are deciding that they can't go it alone when it comes to distribution. We expect this concept of swapping track record for distribution will gain momentum in the months ahead." FRC has in fact dubbed this process Turnerization and expects it to become the fourth major approach to obtaining distribution. The top three: doing it in-house, outsourcing the responsibilities to a third party and paying for it through supermarkets and broker-dealers.
Turner's distribution deal is already paying off. About $500 million has come into the firm's large-cap funds through the new alliances, roughly tripling their size. Meanwhile, Turner's 11 proprietary funds, including its staple small- and midcap funds, as well as its year-old Turner Technology Fund, garnered $500 million in new assets on their own. The added investment has put an exclamation mark on an extraordinary year for Turner, whose assets have more than quadrupled, to $12.5 billion (about 70 percent is institutional).
Never before has distribution been such a pressing issue for fund companies, in both the retail and institutional markets. A recent report, "Success in Investment Management," issued by Merrill and Barra Strategic Consulting Group, concludes that the current "open architecture" environment in financial services, in which firms sell both proprietary and nonproprietary products, will force firms to treat portfolio management and distribution as distinct enterprises. Only a handful will succeed on both fronts. "In the next generation," the report predicts, "investment manufacturing and distribution will no longer be able to cross-subsidize each other."
For fund companies the rising cost of third-party distribution (the average annual cost for firms with between $10 billion and $60 billion in assets was $60 million in 1998, according to FRC), as well as the requisite advertising expenses ($5 million a year, on average, for firms Turner's size) makes the Turner approach an attractive option for managers of highly rated but relatively obscure funds. And, says FRC consultant Thomas Tyson, "distributors realize they need better quality products."
Pete Moran, Turner's chief marketing officer, reports that three money managers have asked him to explain how Turner went about making its deals with Vanguard and Merrill. Almost certainly, more deals will follow.
"It's more complex than you might think," Moran says. "A lot of pieces need to fit. First, you need good performance - at least a three-year track record. Second, the asset class has to make sense for the distributor. And it has to make sense for the manufacturer. You wouldn't want to turn over your flagship product. We realized that we had two large-cap equity funds, not our main area of expertise, that were performing well but just weren't attracting many assets." Virtually all of the other Turner funds were growing on their own, with some closed to new investment and others approaching that point.
Analysts expect that firms with between $500 million and $5 billion in assets and at least five funds in their roster will benefit most directly from the Turner approach. "The trick is to find the one or two diamonds in the rough - funds with great track records but no assets," Moran says.
The Turner Large-Cap Growth fund, which Merrill renamed the Mercury Select Growth fund, reported an average annualized return of 41 percent between its February 1997 inception and June 30, 2000. That compares with a 27 percent average annual return for the Standard & Poor's 500 index during the same period. Meanwhile, the Turner Growth Equity fund, a portfolio that includes a wide selection of large-cap stocks and a smattering of midcaps, reemerged as the Vanguard Growth Equity fund. Between its launch in April 1992 and June 30 of this year, the fund reported an average annualized return of 23 percent, versus 19 percent for the S&P.
Though Turner will now collect about 60 basis points per dollar of assets as the subadviser, less than the full management fee of 75 basis points, he expects that the increased net asset growth will more than offset the short-term drop in revenues.
Merrill is very happy with its new relationship. "Large-cap isn't necessarily Turner's core competency, but the firm had an outstanding track record," says Mark Cone, president of Merrill's Mercury Funds. "For Turner, I would say letting us rebrand the fund borders on a brilliant move."
But the brokerage firm is not looking to duplicate the arrangement with another fund family any time soon, Cone says. The Turner alliance came as Merrill was making an effort to bolster its Mercury funds, making them more attractive to salespeople outside of Merrill. Adds Cone, "This was a one-time deal."
Vanguard, on the other hand, is constantly searching for sharp stock pickers. The fund company outsources approximately $140 billion of its $573 billion in assets to active equity managers. "We're always on the lookout for good managers," says Dickson, who helps oversee the two dozen active managers who serve as Vanguard's subadvisers.
"In the case of Turner, we were looking for a growth fund with a little bit more of an aggressive approach than our other offerings," Dickson says. "The fact that we were able to team up with such a well-regarded institutional manager with a demonstrated track record and one that was willing to turn the existing vehicle over to us, that was clearly a big benefit. But we are not going to hire someone just because we can get immediate access to a top-quartile track record. We have to have confidence in the people and the investment process."
Turner and his firm met both criteria.