Dreman, Miller Fired by Fund Firms Too Soon

NEW YORK ( TheStreet) -- Fund companies often lecture shareholders about the need to hold for the long term. All too often investors panic at market bottoms, dumping their shares at the worst possible time -- and missing stock rallies. That happened last year when funds faced a flood of redemptions.

But retail investors aren't the only ones who make questionable moves at market bottoms. Fund companies recently fired several prominent managers, including David Dreman, former manager of the DWS Dreman High Return Fund ( KDHAX); Bill Miller who oversaw part of the Masters Select Equity Fund ( MSEFX); and Robert Turner of the Vanguard Growth Equity Fund ( VGEQX).

Those managers had suffered periods of poor performance. But after they were fired, their investing styles came roaring back.

Consider Dreman, who ran the fund from 1988 until he was replaced in June 2009. A diehard value investor, Dreman bought stocks at deep discounts. While the approach periodically suffered dry spells, Dreman always rebounded. In recent years, Dreman recorded big losses because he favored troubled financial businesses. Still, his fund had outdone 66% of his large-value competitors during the 15 years before he was sacked.

The company changed the fund's name to DWS Strategic Value ( KDHAX), and replaced Dreman with managers who buy stocks that sell at moderate discounts. The strategy is bound to be less volatile than Dreman's deep-value method. But it's unclear if shareholders are well served by the change in portfolio managers.

After Dreman was replaced, DWS Strategic Value returned 22% for the last six months of 2009. That was 5 percentage points less than a fund Dreman has continued to run, Dreman Contrarian Large Cap Value ( DRLRX).

The trouble experienced by Dreman and the other recently replaced managers highlights a problem with subadvised funds. These are funds run by outside managers on a contract basis. In Dreman's case, he was hired to run a fund owned by DWS Investments.

Most fund companies don't use subadvisers. Companies such as Fidelity Investments and T. Rowe Price ( TROW) rely on employees to run funds. Such in-house operations typically recruit young people and train them as analysts. Eventually the best performers are promoted to be managers.

Some managers work as both in-house employees and subadvisers. The most notable such manager is Bill Gross, who's best known in his role as an employee of PIMCO overseeing PIMCO Total Return ( PTTAX), the largest mutual fund. Gross is less recognized for his work as the subadviser for the Harbor Bond Fund ( HABSX). In that capacity, Gross is paid by Harbor Funds, a company that relies entirely on subadvisers.

Companies that sell subadvised funds claim they can deliver superior results because they can choose the best manager from dozens of candidates. If a subadviser fails to deliver, he can be easily fired. But picking the top outside managers is no easy feat. As the wave of recent firings demonstrates, fund companies don't always replace subadvisers at the best times.

The lack of patience with outside managers may explain why subadvised funds have not outperformed in-house competitors. According to a recent study by Financial Research, internally managed funds returned 1% annually during the five years through June 2009, while subadvised funds returned 0.3%.

"There isn't any data to suggest that subadvised funds perform better," says Lynette DeWitt, Financial Research's director of research for the subadvised funds.

To find out if your fund is subadvised, check its prospectus. That will indicate the manager's employer.

Should you avoid subadvised funds? Not necessarily. Some have top records.

But before you buy, you need to evaluate the fund's returns, and then review the fund company's track record for hiring and firing managers. If the company has a revolving door for managers, stay away.

One fund that has gone through a slew of managers in recent years is the Managers Special Equity Fund ( MGSEX). Despite all the changes, the fund remains in the bottom half of its category.

Hartford Mutual Funds is one of the top employers of subadvisers. Hartford Capital Appreciation ( ITHAX) and Hartford Dividend and Growth ( IHGIX), which are run by Wellington Management have strong performance records.

Harbor Funds has also demonstrated its ability to pick top managers and stick with them for years. Bill Gross began running the Harbor Bond ( HABDX) in 1987, the same year that subadviser Hakan Castegren began overseeing the Harbor International Fund ( HIINX). Spiros Segalas took charge of Harbor Capital Appreciation ( HCAIX) in 1990. Those funds have outpaced most of their competitors by wide margins during the past five years.

-- Reported by Stan Luxenberg.
Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.

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