Ask a computer software programmer, a politician, a shoe fashionista or an asset manager like me what “platform” means and you will get four very different answers. In the financial services industry, a “platform” usually refers to a set of money managers assembled and offered by a bank, brokerage firm or investment management company. Platforms can benefit both investors and managers. Investors benefit by finding a menu of managers who have been vetted by the professional creator of the platform. Managers benefit by getting access to a source of potential investors.
It’s not a perfect metaphor, but if you’ve ever shopped at London’s Burlington Arcade, the architectural jewel that houses that city’s top luxury stores, you get the idea. It’s one-stop shopping for top-of-the line products. The arcade saves you the trouble of trying to find the best stores yourself. Platforms offer convenient access to a range of funds, consolidated administration and reporting, and other services that result from economies. They also tend to be on the cutting edge of the industry. If a new asset class -emerges, for instance, platforms are more likely to learn about it before registered investment advisors.
Platforms come in many guises. There are platforms for trading mutual funds and exchange-traded funds. There are platforms for investing in unified managed accounts and separately managed accounts. There are platforms for alternative investments, including liquid alternative mutual funds, hedge funds and managed futures funds.
Platforms may look alike, but that doesn’t mean they are all equal. This is especially true of an alternative investment platform. That’s simply because alternative investments funds are more complex than traditional ones. That’s why, if you are considering an alternative investment platform for your clients, I recommend that you test the planks first.
Alternative investment fund platforms all strive toward the same goal of finding the best managers. The search begins with a familiar checklist: Is the manager’s track record verifiable? Is it repeatable? How much risk was involved? Are there any signs of style drift? Who audits the returns? How secure are the proprietary trading systems? What’s the back-up plan if another Hurricane Sandy hits?
As a registered investment advisor, however, you should ask additional questions. You should ask me, “As the overseer of a platform, how often do you conduct due diligence on your managers? Is it ongoing or just a one-time deal? Do you ever visit managers, or do you just speak with them on the phone? How often? Who actually conducts your due diligence?”
Then, you should drill deeper. During your “tour” of the platform, you should find out how many managers are on the platform and the level of each manager’s assets under management. Some platforms may have 50 or more managers, but only a handful may be viable, that is, have a meaningful level of AUM. In general, it’s better to avoid startup funds in favor of funds that have a reasonable level of AUM. The reason is simple—the bigger the AUM, the more the administrative costs get spread around among investors.
Administrative costs? Yes, beyond the hedge fund’s typical 2-and-20% management and incentive fees, there are administrative costs that are passed along directly to investors. These costs, which can take some digging to quantify, cover items like audits, accounting, legal services and technology spending. Say a fund pays $30,000 in annual accounting fees. It is a no-brainer that you would prefer that your client be 5% of the AUM and pay $1,500 instead of 50% of the AUM and pay $15,000. Just as obvious, the smaller the AUM, the bigger impact administrative costs will have on performance. A $20,000 audit for a startup with $1 million in AUM means investors give up 2% of performance. Some funds also amortize expenses, so there’s a good chance its startup costs will have been paid over the first five years.
A fund’s offering memorandum spells out which administrative costs will be passed along to investors, but it won’t give actual numbers. The only way to find out is to ask the fund’s providers—its lawyers and accountants—or read its annual report. A platform overseer has both the cloud and the capability to ascertain those costs and to negotiate them downward. Platforms charge for providing this service, but we at Altegris believe platforms offer advantages worth paying for.