A sub-advised fund is a type of investment fund managed by another investment advisor or team, known as a sub-advisor. Sub-advisors are specialists in investment strategies and are responsible for most investment decisions. Furthermore, it is essential to note that sub-advisors do not hold the assets of a mutual fund; instead, they only manage them.
Let us understand the sub-advised fund’s meaning in detail, explore its key features, and see how it benefits investors.
What is a sub-advised fund?
A sub-advised mutual fund involves two parties:
- Primary investment advisor
and - Sub-advisor
The primary investment advisor is the main entity responsible for overseeing the fund. They delegate the fund management to another investment manager, known as the sub-advisor.
After delegation, the sub-advisor makes day-to-day investment decisions and manages the assets within the scope defined by the primary advisor. Thus, you can think of a sub-advisor as an “external manager”. Mostly, they have expertise in a specific area, such as a particular:
- Geographical market
- Asset class, or
- Investment style
Understanding sub-advised funds with example
Let us understand the concept of a sub-advised fund better through a hypothetical example involving an XYZ mutual fund, which:
- Invests predominantly in large-cap US companies
and - Is managed by a sub-advisor with expertise in US markets
In this case:
- The primary investment manager is XYZ mutual fund.
- The sub-advisor is a US-based investment firm with specialised knowledge of the US equity market.
- This firm is responsible for:
- Stock selection
- Portfolio construction, and
- Ongoing management of the US equity portion of the fund.
- By investing in this mutual fund, investors gain access to the expertise of a specialised US market sub-advisor. This enhances their chances of earning a higher dividend and capital appreciation.
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Key features of sub-advised funds
Sub-advised funds are popular investment vehicles and play a crucial role in the world of investments. Let us study some key features of sub-advised funds:
Third-party management
Third-party investment firms or advisors manage sub-advised funds. The primary investment manager, such as a mutual fund company, hires these external managers to oversee:
- A portion
or - The entirety of the fund’s assets
- Mostly, these sub-advisors take charge of:
- Making investment decisions
- Executing trades, and
- Managing the portfolio of the mutual fund
Specialised expertise
One of the primary reasons for employing sub-advisors is to benefit from their specialised expertise. Sub-advisors have in-depth knowledge and a strong track record in managing particular types of investments, such as:
- International stocks
- Technology sectors
- Fixed-income securities
They bring an in-depth understanding of niche markets to the mutual fund schemes. Using their expertise, the primary investment manager generates higher returns for the fund.
Portfolio enhancement
The involvement of sub-advisors significantly enhances the overall performance of the investment portfolio. By using the specialised skills of sub-advisors, the primary fund manager can offer a more diversified and robust investment product.
Furthermore, such a delegation helps in:
- Improving portfolio performance
and - Diversifying the fund’s holdings
- Both benefits reduce the risk and increase the potential returns of sub-advised mutual funds.
Formation and purpose of sub-advised funds
It is noteworthy that sub-advised funds emerge from strategic partnerships within the investment management industry. These funds are formed through the collaboration between the:
- Primary investment management company
and - Specialised third-party investment advisors, known as sub-advisors
Let us look at some key steps of the formation process:
- Step I: Strategic decision
- The primary investment manager identifies the need to enhance their fund offerings and returns.
- Thus, they seek experts with deep knowledge and skills in specific areas, such as particular markets or asset classes.
- Step II: Selection of sub-advisor
- A thorough vetting process is conducted.
- A sub-advisor is chosen with a strong track record and expertise in a particular investment area.
- Step III: Agreement
- A contractual agreement is established with the sub-advisor.
- It specifies:
- Roles
- Responsibilities, and
- Compensation
- Step IV: Integration
- The sub-advisor’s investment strategies are integrated into the primary manager’s fund offerings.
- Step V: Monitoring
- Continuous oversight is maintained.
- This monitoring ensures that the sub-advisor adheres to the:
- Agreed-upon strategies
and - Performance metrics
- Agreed-upon strategies
By hiring sub-advisors, a fund manager enhances the overall returns of the mutual fund and offers a more diversified product.
Pros of sub-advised funds
Delegating the fund's management to external firms offers several benefits to primary fund managers and investors. Let us see some major benefits:
- By hiring sub-advisors, primary managers can focus more on their core competencies, such as marketing and compliance.
- Sub-advised funds allow investment managers to offer a broader range of investment options to their investors.
- Engaging specialised sub-advisors improves the fund’s performance due to their deep expertise.
Cons of sub-advised funds
Sub-advised funds have the potential to generate greater returns for their investors. However, they also come with several disadvantages that investors and primary investment managers must consider. Let’s understand them:
- Higher fees
- Sub-advised funds often carry higher fees compared to funds managed solely by the primary investment manager.
- This is because the sub-advisor charges fees for their:
- Specialised expertise
and - Management services
- Specialised expertise
- These additional costs are usually passed on to the investors.
- Thus, investors face double layers of fees:
- One for the primary manager
and - Another for the sub-advisor
- One for the primary manager
- This leads to higher expense ratios.
- Complexity in management
- Managing a sub-advised fund involves coordinating between:
- The primary investment manager
and - The sub-advisor
- The primary investment manager
- This additional layer of management leads to complexities.
- It can create a “misalignment” in investment strategies and their execution.
- Also, there could be potential conflicts of interest between the primary investment manager and the sub-advisor.
- Managing a sub-advised fund involves coordinating between:
Investment in sub-advised funds
When you invest in a sub-advised mutual fund, you place your capital in a mutual fund managed by a primary investment manager who delegates the portfolio management to an external specialist, known as a sub-advisor.
This kind of delegation allows investors to benefit from the sub-advisor's expertise in making strategic investments. When it comes to the role of a primary investment manager, they oversee the fund's:
- Overall strategy
- Marketing, and
- Compliance
Simultaneously, a sub-advisor focuses on selecting investments and managing the portfolio. This arrangement enhances the performance of a mutual fund and improves its efficiency.
However, investors should be aware of the higher fees associated with these funds, which are used to compensate the sub-advisor for their services.
Benefits of sub-advised funds despite higher fees
Despite the additional costs, sub-advised funds are an attractive option for investors due to their:
- Potential for superior returns
and - Diversification
These funds offer significant benefits that outweigh their higher fees. Let’s study them:
Diversification and specialisation
Sub-advised funds provide substantial diversification benefits. That’s because these funds invest in a broad range of:
- Asset classes
and
- Investment strategies
Furthermore, the specialised expertise of sub-advisors allows the fund to access niche markets or sectors that the primary manager may not cover. This targeted investment creates a more balanced and resilient portfolio.
For investors, this means access to a more comprehensive investment strategy, which is based on the strengths of both:
- The primary manager
and - The sub-advisor
Strategic flexibility and innovation
Sub-advised funds offer strategic flexibility and innovation in portfolio management. Delegation helps primary investment managers to quickly adapt to market changes by using the sub-advisor's specialised skills. This adaptation allows a mutual fund to capitalise on emerging opportunities without the need for the primary manager to develop in-house expertise.
Furthermore, sub-advisors often introduce new investment techniques and perspectives. This results in more effective risk management and the potential for higher returns.
Key takeaways
- Sub-advised mutual funds are managed by third parties or sub-advisors.
- These advisors possess deep expertise in managing certain types of investments.
- The primary investment manager aims to improve the fund's overall performance by benefitting from the sub-advisor's specialised skills and insights.
- While sub-advised funds can boost performance, they come with additional costs.
- The sub-advisor must be compensated for their services, which usually results in higher fees for the investors.
- This fee is usually a percentage of the assets under management and is in addition to the fees charged by the primary investment manager.
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Conclusion
Sub-advised mutual funds are an effective investment option. These funds benefit from the specialised expertise of third-party managers that enhances their portfolio performance and diversification.
By involving sub-advisors, these funds access niche markets and specialised strategies, which offer investors the potential to earn superior returns. However, it is important to be aware of the higher fees associated with these funds, which compensate the sub-advisors for their expertise.
Despite these costs, the benefits of enhanced diversification and improved portfolio management present a strong case for considering these investment options.
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