To some investment managers, setting up a mutual fund is akin to planting the corn and slaughtering the pig just to make a pork chop. After all, why spend time and money assembling a research team, portfolio manager, performance record and sales and marketing forces when you can farm out the tasks?
Manufacturers do it. Payroll departments do it. And, increasingly, asset management firms do it. Outsourcing, already an engine of growth for the mutual fund industry, will put even more funds on the table in coming years by allowing investment companies to increase quickly the breadth of their offerings.
"All of these guys are for rent -- why would I want to own one?" asks Bradford K. Gallagher, whose small Boston firm, Cypress Tree Investments, uses companies from Salomon Brothers to Wellington Management Co.
What might be dubbed the "rent-a-fund-manager" trend has swelled in recent years, driven by investment firms racing to create more funds faster and by institutional money managers who have looked with envy at the lucrative fund industry and scurried to offer their services. Known as sub-advising, the practice has also spawned the growth of "virtual" fund shops that lack trading desks, money managers, and research teams.
Even though fund prospectuses clearly state who oversees a portfolio, ordinary investors might be surprised to learn how many mutual funds are actually run by a money manager at another company. Nearly one in seven mutual funds is sub-advised, including 32 percent of all international stock funds, according to Financial Research Corp., or FRC, a Boston consulting firm. For US diversified stock funds, the figure is nearly one in three.
Even the most well-known fund firms, including Fidelity Investments, use sub-advisers, particularly for exotic overseas offerings or for products, such as variable annuities, for which they may not have in-house expertise. Vanguard has Wellington run many of its funds, including the $18.3 billion Windsor fund.
Such an arrangement is appealing. An investment firm wanting to expand into, say, an airline stock fund but not wanting to hire an expensive sector analyst can pay someone else to take the reins.
By contracting things out, investment firms are not just gaining efficiencies of scale and economy. They are also responding to growing consumer demand for a fuller range of funds within individual firms. Such pressure has created more than 11,000 mutual funds (including mutiple share classes), more than triple the number of listed companies on the New York Stock Exchange.
Increasingly, single funds are run by managers spread out across several companies. For example, a firm with a large capitalization fund with a heavy technology component might hire a name-brand tech stock picker just for that part of the fund. The Star Advisers Fund, a growth fund that is part of NVest's New England Funds family, has three sub-advisers, each overseeing a different part of the portfolio.
That practice will grow, says FRC analyst Ray Liberatore. In all, Liberatore predicts sub-advised funds will account for 20 percent of all funds, compared to 13.5 percent now.
If past returns mean anything, that could be good for investors. Sub-advised U.S. equity funds returned from a half to a full percentage point more than their internally managed counterparts over one, three, five, and 10 years through November, according to Morningstar. And that is after slightly higher fees, which are split between the sub-adviser and the company marketing and selling the fund, are factored in.
On the other hand, sub-advised international funds have lagged behind their internally managed peers, perhaps because they compete against a few powerhouse firms already rich in overseas research and stock-picking skills.
Once confined to secretive shops like Wellington and Standish, Ayer, sub-advising is increasingly attractive to mainstream investment banks and institutional money managers who want more of the hot "retail" fund business that caters to ordinary Americans, who have fueled the investment boom this decade.
But the field is fraught with peril. Sub-advisers can be -- and are -- sacked more readily than in-house portfolio managers, since they are not full-time staffers with complex employment contracts. "The sub-adviser doesn't control his own destiny," says Philadelphia-based fund consultant Burton J. Greenwald, citing the subadvisor's inability to influence how a fund is marketed. "He lives a precarious existence."
Pub Date: 12/27/98