Sub Advised Fund

A sub-advised fund is an investment fund that is managed by another management team or firm than where the assets are held.
Sub Advised Fund
3 min
05-July-2024

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
  • Step V: Monitoring
    • Continuous oversight is maintained.
    • This monitoring ensures that the sub-advisor adheres to the:
      • Agreed-upon strategies
        and
      • Performance metrics

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
    • 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
    • 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
    • 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.

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:

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.
  • Do you have an active SIP in mutual funds? Check out your potential maturity amount today using our free mutual fund calculator.

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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Frequently asked questions

Is a sub-fund a legal entity?
No, a sub-fund is not a legal entity. Instead, it is a separate pool of assets within a larger legal entity, such as an umbrella fund in investment management.
What are sub-advisor fees?
Sub-advisor fees are compensation paid to external investment managers (sub-advisors) hired by a fund to manage a portion of its assets.
What is the difference between a fund and a sub-fund?
A fund is a collective investment vehicle, while a sub-fund is a pool of assets within that fund. In other words, we can say a sub-fund is a sub-set of a larger fund.
What are umbrella funds and sub-funds?
An umbrella fund is a collective investment scheme operating as a legal entity. Within these umbrella funds lie several sub-funds having their own investment objectives and strategies.
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Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.