Get the Best of Breed Funds

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ALL TOO MANY investors face a common experience: They buy a top fund, and then the manager leaves. The new manager can't match the old results. One way to avoid such disappointments is with best-of-breed funds. These funds hire top freelancers known as subadvisers. For example, Fremont Bond employs Bill Gross, the noted fixed-income manager, who has long outperformed the benchmarks while steering his flagship Pimco Total Return fund. Many top Vanguard funds, such as Vanguard Windsor II, hire subadvisers.


For the moment, subadvised funds remain in the minority. Most fund families, including Fidelity and T. Rowe Price, follow the traditional approach, managing money internally. They hire young graduates and train them as analysts, eventually promoting top candidates to be portfolio managers. In contrast, when a fund uses subadvisers, it screens hundreds of outside managers and hires a few freelancers to oversee assets.


While internal management has produced plenty of successes, subadvising has clear advantages. Sub-advised companies can pick from the very best talent, taking proven stars with long records of success. And when a subadviser suddenly runs cold or shifts his style, the fund company can easily dump him and pick someone else. “By using outsiders, you can find people with distinctive strategies and strong organizations,” says Jeff Molitor, who consistently reviews portfolio managers at Vanguard. 


With so much talent at their disposal, it is not surprising that subadvised funds often outdo internally run competitors. During the past five years, subadvised bond funds re-turned about 0.4% annually more than internally managed competitors. Subadvised stock funds also outdid their rivals.


While the average returns are intriguing, it is particularly noteworthy that some fund families have proven deft at picking the right subadvisors. At the top of the heap is Masters Select Advisors, which hires several advisers for each of its portfolios. While Masters Select Value outdid 92% of its competi-tors in the past five years, Masters Select Equity outdid 90%. Other strong fund families with subadvisers include Managers Funds, En-terprise Group of Funds, and Harbor Funds.


How can you tell if a fund is subadvised? Some companies advertise the fact, saying that they have hired a star like Tom Marsico, a long-time winning stock manager. Otherwise you can check the fund prospectus under the section that is usually labeled “investment adviser.” If the fund is using an outsider, it could  be worth buying.

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