Many Firms Get Outside Help Managing Portfolios

Sometimes it’s better for mutual fund managers to admit they lack certain skills than to prove it to themselves and shareholders the hard way.

That’s what Bennington Capital Management, which has run bond funds for almost seven years, decided in late 1995 when the money-management firm wanted to offer stock funds.

Instead of trying to run its Accessor Small-MidCap Portfolio itself, Bennington went outside and hired Symphony Asset Management to manage the stock fund.

“We don’t have an expertise managing stock funds, so why not leverage off someone else’s expertise?” said Ravi Deo, Bennington’s chief investment officer.

Bennington’s choice proved to be a good one. Accessor Small-MidCap rose 46.5% in the last 12 months, ranking No. 13 of 359 small-capitalization stock funds tracked by Bloomberg Fund Performance. The fund now has $205 million in assets.

It’s not uncommon for funds to hire outside managers. About 14% of the industry’s more than 4,740 portfolios are run by outsiders, according to Financial Research Corp., a Boston-based research firm.

Vanguard Group, Scudder Kemper Investments, Charles Schwab, Federated Investors and John Hancock Funds all retain outside firms to manage some funds. Even Fidelity Investments gets help from an outside advisor, Bankers Trust New York, to manage some index funds.

Outsiders often offer the best choice; their firms have managed pension money and private investors’ funds for years. They can be cheaper than hiring inside managers; the funds can pit the outside firms against one another and reduce the management fees they pay. And it’s easier to fire a poorly performing manager when he or she doesn’t sit next to you.

The average U.S. stock fund run by an outside manager is generating annual returns that are about 1.5 percentage points better than rival internally managed funds, said Ray Liberatore, an analyst at Financial Research.

“A lot of fund companies are going to experts in the industry to manage their funds, and they’re getting their money’s worth,” he said.

Some of the top-performing outside-managed funds of the last few years along with the Accessor fund are the Hartford Capital Appreciation Fund and the Heritage Capital Appreciation Trust, Liberatore said.

The Heritage fund rose at an annual rate of 21.9% the last five years, ranking No. 11 of 90 “aggressive growth” stock funds, followed by Bloomberg Fund Performance. The Hartford fund increased 38.3% in the last year, placing No. 17 of 264 “aggressive growth” funds tracked by Bloomberg.

Outside managers such as Symphony Asset Management made a name for themselves while overseeing accounts for institutional investors, who tend to be tougher critics of portfolio managers than mutual fund investors. Institutional investors are less patient because they tend to have more money at risk and therefore aren’t reluctant to change managers when returns lag.

Bennington picked Symphony because “the probability of them outperforming was high, and the probability that they would do something stupid was minimal,” said Deo, who had 200 interviews with potential managers before hiring Symphony. Bennington and Symphony share the management fees generated by the Accessor fund. “We want firms that have a clearly defined investment style that we can understand,” Deo said.

Symphony, for instance, uses computer programs to identify stocks worth buying from a list of hundreds. The review includes a traditional analysis of a company’s balance sheet and business prospects, as well as a look at Wall Street research to pinpoint the analysts who are best at following a particular company.

Symphony’s managers try to identify analysts who make the best earnings forecasts and the most timely investment rating changes, and this information is worked into the investment model.

“It’s a philosophy we think makes sense, and if it doesn’t, we can change managers,” Deo said. “We can look at the facts in a cold, dispassionate way, and we don’t let personal feelings get in the way.”

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Tim Quinson is a mutual fund writer for Bloomberg News.