From the July 2007 issue of Investment Advisor • Subscribe!

July 1, 2007

A Fund of Your Own

Pooling client assets may be the solution to a number of problems

It's no secret that with overhead, compliance, and professional costs rising, advisory practice margins are being squeezed like never before. Neither is there any mystery about the solution that many consultants recommend today: jettison your unprofitable clients. Of course, in many cases that amounts to more than 50% of an advisor's client base, which can be a problem for client-oriented, rather than business-oriented advisors. Not only are those "outgrown clients" likely to be long-term clients, many of those "marginal" clients are typically relatives and friends of much wealthier clients who were taken on as favors, and cutting them loose is really not an option.

How then is one supposed to improve eroding practice economics while keeping all current clients on board? My friend Ron Rog?(C) in Bohemia, New York, has been wrestling with this issue for at least the past 10 years. He's tried newsletters, model portfolios, and limited service offerings, all in an attempt to reduce the cost of servicing the smaller clients in his and other practices. A few years ago, he adopted a more radical strategy, which seems to have provided the solution for his practice, and may help yours as well. He launched his own mutual fund.

Like many good ideas, Rog?(C) literally stumbled on this one. Back in the '90s, he read a Barron's interview with the great Ralph Wanger, founder of the Acorn Fund. Wanger mentioned that he had originally been an investment advisor and started his legendary mutual fund as a courtesy for relatives of his wealthy clients. Hmmm, thought Rog?(C), "a mutual fund for smaller clients..." But the cost of launching a fund is considerable, so he mentally filed the idea until he felt his practice could afford it.

A Low-Minimum Option

About four years ago, when Rog?(C)'s son Steve joined the business full time, after earning his bachelor's degree in finance and economics, he felt it was time to seriously consider the fund idea. "So, we started kicking around ways to make it work," he remembers. When Rog?(C) says "we," he's not talking about the kind of brain trusts found at some largest firms today. With $250 million under management, R.W. Rog?(C) & Co. is family owned, with Ron and his 26-year-old son, Steve, working as co-portfolio managers in the firm along with two CFPs, a portfolio operations manager, a paraplanner, and five support staff.

What "they" came up with is the Rog?(C) Partners Fund, which will be three years old on October 1. He describes it as "mostly a fund of funds," with a $5,000 minimum investment ($2,500 for IRAs). What that means in practical terms is that 70% of fund assets are invested in mutual funds, hedge funds, or private equity partnerships managed by R.W. Rog?(C) & Co., Inc. As co-portfolio managers for the fund, Rog?(C) and Steve divide responsibilities so that each can focus on their core strengths, then they collaborate and make decisions on security selection together. So with his economics background, Rog?(C) focuses on generating ideas and allocation strategy based on the global economy, while Steve handles value opportunities and indvidual security research. Steve's stock selections represent about 30% of the fund.

Client assets are being managed by a 26 year-old? Sounds like the kind of nightmare that gives independent advisors a bad name. "Steve's age can put people off," admits Rog?(C). "That is, until they talk to him. Then they realize when it comes to investing, he can go toe to toe with anybody. We like to say that Steve is a 26-year-old with 14 years of experience, because he literally grew up working part-time in the ofice asking lots of questions about the business."

Father's pride perhaps, but Steve Rog?(C) has the chops to back it up. He's been in the top 100 stock pickers in the prestigious Meritocracy Fund online challenge many times, and he was recently elected chairman of the Ben Graham Value Investing Committee of the New York Society of Securities Analysts. Oh, and last year, Rog?(C) Partners Fund (ROGEX) was named one of the Wall Street Journal/Lipper's Category Kings for Multi-Cap Core Equity Funds for the previous 12 month performance (as of 9/30/06), based in no small part on Steve's stock picks.

In fact, Steve's contribution helped Rog?(C) Partners Fund to outperform Rog?(C) & Co.'s wealth management portfolios, which hold similar mutual funds, but not individual stocks. To rectify that situation, at the end of this month, they'll be launching another fund, Rog?(C) Select Opportunities, which will be focused on 20 to 40 stocks and made available to the firm's wealth management clients.

"The new fund isn't for everyone," says Rog?(C). "But we ran the idea by some of our largest clients, including several high-earners on Wall Street, and every one told us to do it. In fact, one guy said he had another $300,000 to give us but thought maybe he should wait to put it in the new fund."

Of course, launching your own mutual fund isn't for every advisor. Yet, even if you don't have an up and coming Ben Graham on staff like Steve Rog?(C), the strategy can make a lot of sense: You're probably already picking and tracking mutual funds, so there isn't much of a management burden. And chances are, you also have plenty of clients would benefit just as much from a conservatively managed fund of funds as from a more labor intensive "individualized" portfolio.

Still, launching and running your own mutual fund does raise some issues that need to be carefully considered. Rog?(C) spent a long time thinking about the management fees, and the potential conflicts of interest they could create. He finally decided to cap fund expenses at 199 basis points, including the expense ratios of the funds it owns. (Rog?(C) believes that as the fund grows its assets that expenses will fall to 149 bps at around the $50 million mark.) He reasoned that the mutual funds in his wealth management portfolios had the same or similar underlying fund and brokerage expenses, and he charges a 1% fee on top of that. So, if he set his fund advisory fees at the same level, he'd have no economic incentive to recommend one over the other. "We wanted to make sure we had no economic incentive to recommend one service or another to our clients," he says. "So we just charge the same fee inside or outside the fund."

While ethically fair, capping expenses at the outset means that the firm is going to have to eat some costs until the fledgling fund has enough assets to pay its own way. Rog?(C) says the breakeven point is around $15 million. Seeded with about $2 million of his own, family and employee money, in 21?,,2 years, Rog?(C) Partners Fund has grown to $17.5 million, finally putting it in the black.

In addition to paying over $100,000 in start-up costs, there are also costs to putting the fund on custodian platforms. Schwab and TD Ameritrade were cooperative in adding Rog?(C) Partners Fund to their platforms, because the firm had assets at both custodians. The fund is on the Pershing and Scottrade platforms as well.

Could You Fire Yourself?

Perhaps the biggest issue for Rog?(C) and any advisor with their own fund is evaluating their own performance. Again, for advisors who are already managing client portfolios of mutual funds, this is just another facet of an issue they already face. But as investment companies, mutual funds do have stricter regulations. So far, Rog?(C) Partners has been blessed with good returns, but they have the added wrinkle of Steve Rog?(C)'s stock picking. What if performance isn't so good? What if Steve's picks start to drag fund returns down? "We realize," says Rog?(C), "that we need to have the courage to fire ourselves."

To help in the intestinal fortitude department, Rog?(C) Partners has a board of trustees comprised of a client, an independent advisor, a fund industry luminary, and outside legal counsel, who represent the fund's shareholders, not Rog?(C) & Co.

While that provides Rog?(C) with some guidance and comfort, it's also a level of accountability that independent advisors aren't used to. "Every year, the board has to decide whether to rehire us as the fund manager," says Rog?(C). "While that might seem like a formality, we treat it seriously."

For most advisors, the cost, the conflicts, and the outside oversight of a mutual fund will be more than they want to take on. Still, the idea of a fund managed for small clients, and with low minimums, strikes me as an attractive solution for those clients you can't live with, but just can't fire. Perhaps opening a fund like Rog?(C) Partners to other advisors would be a viable alternative. In that case I'd suggest he cut his fee down from 199 bps to 149 bps, leaving room for other advisors to collect 0.5% on their smaller clients. But that might require creating a new fund, with a whole new set of expenses, which may not be worth it for a mid-size advisor like Rog?(C). Seems like such a good idea, though, that sooner rather or later, someone will offer such a fund, and collect a pretty good amount of assets while helping advisors and their smaller clients.

The other aspect of Rog?(C)'s fund strategy that struck me was the reception that his new fund got from his larger clients. In today's environment, with increased competition, and armies of brokers masquerading as fee-only fiduciaries, professional financial advisors increasingly have to find creative ways to differentiate themselves. Creating their own mutual funds, or other pools of assets, that collectively offer clients some economies of scale and access to investment opportunities that are unavailable to their individual portfolios just may be a way to do that. Seems like the kind of win/win that independent advice is all about.


Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at rclark7000@aol.com.

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