Subadvisers provide outside expertise to mutual funds

NEW YORK -- When trying something new, it's not unusual to look to an outside expert for help.

That's what a growing number of mutual fund and other financial businesses are doing to stay competitive. Instead of relying on an inhouse team to launch new funds or overhaul others, they're turning to specialists from different firms for guidance.

As a result, one out of every nine mutual funds in 2000 hired what are called subadvisers, according to the Financial Research Corp., a trend that is expected to continue.

"The norm is for the subadviser just to manage the money associated with a fund and then report back to the mutual fund company," said John Benvenuto, an FRC analyst. "The fund company will do all the other stuff: administration, bookkeeping, auditing."

Funds tend to hire subadvisers in areas where they lack experience. Saving money can be another incentive, since starting up a fund from scratch can be extremely expensive.

Subadvisers can also allow a financial business with no fund experience to offer its own line of funds. An insurance company might contract with a fund company to create and manage a fund that is sold exclusively through the insurance company. (To find out if a fund is subadvised, investors should read the prospectus or ask a sales representative who is managing a fund's assets.)

Among the biggest subadviser clients are Vanguard and Fidelity, who each use subadvisers in areas outside their respective expertise. Vanguard, which is known for index funds, uses subadvisers to run nearly all of its conventional stock mutual fund offerings. Conversely, Fidelity, which made its name in stock picking rather than indexing, relies on hired help for its index funds.

Cost-effective management

Subadvisers "can manage index funds more cost effectively than we could," said Fidelity spokesman Vincent Loporchio. "This arrangement allows us to focus on what we do best, and that's bottom-up, stock-by-stock equity research."

Jeff Molitor, Vanguard's director of portfolio review, believes subadvisers bring different views to the table also, in contrast to an inhouse portfolio approach in which funds are influenced by the views of one research team.

Subadvising "means investors end up getting diversification of thought across their portfolios," he said. "You're not going to find as much overlap because each investment firm looks at the market differently."

On average, subadvised funds carry expense ratios of 1.22 percent, about 14 percent higher than their internally managed counterparts. (Expense ratios are a fund's operating costs experessed as a percentage of its average net assets.) The FRC data found that across the 5-year period ending last December, some subadvised funds outperformed internally managed funds, although by a narrow margin and not consistently.

Not everyone's convinced the premium is worthwhile.

"In some cases you may be overpaying for a fund that you could go get directly from the subadviser for less," said Mercer Bullard, founder of Fund Democracy, a shareholder's rights group.