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Shakeup at a Subpar Emerging-Markets Fund

No halfway measures here.

Gregg Wolper, 12/04/2012

For decades, certain mutual fund firms have delegated the day-to-day management of their funds' portfolios to others. For example, though Vanguard serves as the advisor of its actively managed funds, it has long relied on subadvisors to pick the securities for many of those portfolios. In fact, Vanguard and many others don’t stop with just one choice: The advisors often assign two, three, or even more subadvisors to separately manage portions of the same fund.

Those subadvisor lineups aren't carved in stone, though. A fund's advisor can make changes. At a multimanaged fund with five subadvisors targeting different areas of the stock market, for example, that might mean swapping the small-cap value specialist for a new firm focusing on the same universe. Or--in a practice that has become common at Vanguard in recent years--the advisor simply adds a new firm without subtracting any of the existing members, expanding the number of subadvisors as the fund’s asset base grows.

Rarely, though, does an advisor sweep out an entire lineup of subadvisors and install a whole new crew. But that's what happened in October at USAA Emerging Markets USEMX.

There One Day, Gone the Next
Until that time, USAA Emerging Markets, which currently has $1.4 billion in assets, had been run by managers from two different subadvisors, Batterymarch Financial and The Boston Company. Batterymarch had been added in October 2006; prior to that, The Boston Company had been the sole subadvisor since June 2002.

Performance under those two firms was not impressive. The fund’s return from the beginning of November 2006 through the end of September 2012 lagged both the MSCI Emerging Markets Index and the diversified emerging-markets category average by substantial margins. The fund also trailed both benchmarks during the prior period when The Boston Company was the sole subadvisor.

So USAA took action. Instead of adding another firm and handing them a portion of assets, or swapping out just one of the two subadvisors, USAA wiped the slate clean. It replaced Batterymarch and The Boston Company with three new firms. (A USAA spokesman says that in addition to performance issues, the firm also considered the way in which the different subadvisor portfolios worked together as a whole.)

Now Lazard Asset Management gets the bulk of assets, with Brandes Investment Partners and Victory Capital Management dividing the remainder. The USAA asset-allocation team may make small adjustments from time to time in the amount of assets under each subadvisor's control. (For more details, Premium Members can look at the new analysis of the fund by Morningstar senior fund analyst William Samuel Rocco.)

Although the three current subadvisors are all solid shops with significant emerging-markets experience, it remains to be seen how the new arrangement will perform in practice over time. What’s most noteworthy was the drastic nature of the action.

Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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