Ideas with Impact
UNB Faculty of Management

Photo: A recent study by Dr. Michael Densmore sheds light on the role of subadvisors in managing international equity mutual funds.

Investing in a diverse group of assets has long been regarded as a strategic approach to mitigate risk in investment portfolios. However, another important facet of risk management involves venturing beyond domestic borders into international markets. In fact, a significant proportion of US investors have flocked to international markets, often through the purchase of international mutual funds. Dr. Michael Densmore, a finance professor at UNB's faculty of management, has delved into the impact of international presence on the performance of such funds.

In a recent research article titled "The Geography of Subadvisors, Managerial Structure, and the Performance of International Equity Mutual Funds," published in the The Review of Asset Pricing Studies, Dr. Densmore, alongside Markus Broman and Pauline Shum Nolan, explores the relationship between the geographical location of fund subadvisors and their overall performance. The study concentrates on international equity funds that are sold to US investors. The nature of these funds, namely that their advisors are headquartered in the US, allows the authors to use subadvisor headquarter locations to identify potential foreign informational advantages.

Subadvisors can play a crucial role in assisting fund advisors in managing assets. They may or may not be affiliated with the asset management firm but provide additional flexibility for fund advisors seeking local expertise in foreign markets. Dr. Densmore emphasizes the significance of the fund advisor's responsibility in monitoring the entire fund-level portfolio, regardless of the number, or affiliation, of the involved subadvisors.

One key aspect addressed by the research is the impact of outsourcing on fund performance. Past literature has shown that outsourced mutual funds typically underperform relative to funds managed in-house due to the agency costs inherent in outsourced relationships. Dr. Densmore's findings echo this sentiment, but also exploit the regulatory nature of subadvisory contracts in the asset management industry to reveal a new channel through which funds can mitigate agency costs in outsourced sub-advisor contracts. In particular, they show that the underperformance is alleviated, and often eliminated, in funds that employ multiple sub-advisors since these subadvisors face stronger threats of termination.

The study also contributes to the broader discussion of local informational advantages. Importantly, their findings suggest that international equity mutual funds do not see performance benefits from hiring subadvisors located within close proximity to their foreign investments.

This research provides valuable insights into the complex world of international equity mutual funds. The study sheds light on the nuanced impact of subadvisors, the consequences of outsourcing, and the potential advantages of having a foreign presence. The findings contribute to the ongoing discourse in asset management, offering a deeper understanding of the factors influencing the performance of funds operating on a global scale. As the industry evolves, these insights may guide investors and fund managers in making informed decisions to optimize portfolio performance in an increasingly interconnected global market.

In 2019, Dr. Densmore and his team won the CFA Society Toronto and Hillsdale Canadian Investment Research Award, a testament to potential impact of their research for investors. They also presented their paper in 2020 to the Chicago Quantitative Alliance Conference.

Dr. Densmore joined the faculty of management in 2022 and teaches Theory of Finance, Investments, Financial Management, and Corporate Finance. His research interests include asset management, investments, credit default swaps, asset pricing models, and market efficiency.

Learn more about Dr. Michael Densmore and about UNB’s Faculty of Management.

Media contact: Liz Lemon-Mitchell