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Portfolio > Mutual Funds

Part of the Solution

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As Mark Hurley wrote over a decade ago, compared to other professions, independent advisors are woefully underserved by their traditional industry vendors. Consequently, independents have to look to innovators who understand their needs to come up with solutions that truly work. That’s why I’m always on the lookout for innovative solutions to the myriad challenges faced by independent financial advisors.

Over the years, we’ve seen remarkable solutions to some of the advisory community’s most perplexing problems: deducting client fees from their portfolios (Schwab Institutional); realizing the inherent value in an advisory practice (FP Transitions); quantifying the business of advice (Moss Adams); consolidating client reports (Advent); outsourcing portfolio management (AssetMark); cost-effectively communicating with clients (Advisor Solutions); and virtual practice management help (Financial Advisor Resources), to name only a few.

Collectively, these companies and others have made major contributions to the current success of independent practices, as businesses. Yet three of the stickier practice management challenges remain unsolved: what to do with smaller clients who really aren’t profitable; how do fee advisors get compensated for advising on client assets in pre-existing, heavily-loaded (is that redundant?) VAs; and how do you cost effectively add the alternative investments that today’s wealthier clients demand?

At least, they’ve been unsolved until now. Recently, I came across Gemini Fund Services in Hauppauge, New York, a 20-year old firm that historically specialized in creating and servicing mutual funds and hedge funds, but which over the past few years started offering what appear to be viable solutions to all three problems faced by independent financial advisors. With $8.6 billion in assets under management for some 45 RIAs, a growing number of advisors seem to think so, too.

A Small Client Solution

Most financial advisors initially come to Gemini because they want to take their hot-shot asset management to a national audience. As you might imagine, that’s about as realistic as playing in the NBA. But lightning does strike some people, so instead of being discouraging, Gemini CEO Andrew Rogers tries to add a dose of reality into the conversation: “I call it the Fund of Dreams,” he says. “Many advisors think that if they just create a mutual fund, investors will flock to it. I tell them to put sales and marketing before the actual operations. We can build the product for them, but first they have to have a business plan for how they will attract client assets. Performance is a good start, but how’s anybody going to know about it?”

The best place to start, of course, is with one’s own clients. Which happily offers what looks to me to be the best solution to the problem of small–but sticky–clients. Everybody has them: they’re some of your first clients, whom your firm out-grew long ago, but you just can’t bring yourself to jettison; they’re relatives or friends of some of your biggest clients, who aren’t anywhere close to meeting your minimums but strengthen your ties to clients who do; and they’re influential stalwarts in your community, whom you view as marketing loss-leaders. Regardless of why you keep them, they continually show up near the bottom of your annual client profitability analysis, yet partly for those reasons above, tend to command much larger portions of your time and energy.

What do you do with them? Suppose you had a mutual fund–probably a fund of funds, with many of the same funds you put in other client portfolios, but tailored to the lower risk tolerance of smaller investors–into which you could place them, consolidating all your smaller portfolios so you can efficiently make decisions about fund selection, and rebalancing across the board. No more complex statements, quarterly client meetings, or phone calls to discuss the latest hot tip they got off The best part is that it’s cheaper for the clients–because you’re spreading your decisions over many clients, you can charge a lower fee.

So the first step toward your own mutual fund is to put the assets of your smaller clients into it. Andrew Rogers tell us that “you want to get at least $25 million in a mutual fund: at that point the expenses become reasonable.” What’s reasonable? Probably about 1.00% or so, Rogers suggests, then adds, “when you get to $100 million, the cost goes down to about 20 basis points.” If they had $25 million, they wouldn’t really be small, unprofitable clients, would they? Good point. But consider this: in many practices the combined resource and time drain of the smaller clients is so pervasive that it’s economically sound to consider underwriting part of the cost of getting them under control. Moreover, your lower-risk fund of funds will likely be appropriate for a portion of some of your other clients’ portfolios as well, which suddenly makes that $25 million hurdle a lot lower.

What’s more, I’d bet you’re not the only advisor in your community who has a smaller-client problem. Your solution might just be a viable solution for some of them as well, especially if you cut them in on the fees. Not only would this help you reach that $100 million critical mass which is a win/win for everyone, but, it seems to me that signing up other local advisors is a much more realistic strategy for taking your mutual fund on the road, than say, trying to get listed on Morningstar, or compete with American Funds.

Solving the Cost Dilemma

The upfront costs to launch a fund can be daunting as well. Rogers says that with the legal, registration, compliance, insurance, and set-up costs, launching a new mutual fund can run up to $75,000. To help defray some of those expenses, Gemini offers what it calls a shared trust option, in which, under a trust umbrella, a number of advisor funds can share the expenses. A shared trust can get the costs down to between $35,000 to $50,000, but the biggest drawback seems to be that one of things you’ll be sharing is a truly independent board of directors–one that is made up of folks you don’t know. Because a fund’s board of directors is empowered to, among other things, remove the investment manager, some advisors aren’t comfortable with this approach. The reality, however, is that the advisor would continue to own the fund investors through what’s called an “advisory contract,” so the only option the board would have is to close down the fund, which obviously Gemini would prefer not to do.

Another solution that Gemini offers is variable insurance trusts. These are for advisors with clients who have existing VAs or can benefit from one as a retirement planning tool. Yet, understandably, many advisors have shied away from getting involved with today’s lineup of heavily loaded annuities. The solution is for advisors to create their own separate account (again, most often a fund of funds) within the flat-fee VA called Monument Advisor offered by Jefferson National. With no life insurance component or surrender charge, Monument charges clients $20 a month, for the tax deferment that is the primary advantage of annuities: and you get to continue to manage their assets. For clients who have or need VAs, that’s certainly one of the best alternatives I’ve heard.

Finally, for advisors trying to attract high-net-worth clients, adding the alternative investments they require can be a daunting and expensive task. For them Gemini offers a hedge fund solution: advisors can create their own fund of hedge funds, consolidating their management efforts while providing acceptable diversification. Gemini offers the administration and internal controls for these higher risk vehicles, and many of their advisory clients turn to them for due diligence on hedge fund options.

With any of these solutions–mutual funds, variable annuities, or hedge funds–the biggest risk is that advisors don’t understand the costs involved, and therefore don’t have a realistic plan to cover them. Rogers suggests that advisors get detailed financial pro formas, and then talk to existing clients of their prospective fund administrator to see if their projections were close to reality.

Of course, most advisory firms probably won’t launch their own mutual funds, VAs, or fund of hedge funds. Yet each of these problems–clients that are too small, with variable annuities, or who want sophisticated alternative investments–will only continue to grow as practice management challenges. Consequently, finding solutions to them will only become increasingly important. In my view, creating your own investment vehicles, or using one created by another advisor you know and trust, is as good a place to start looking for answers as any I’ve seen so far.

Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at [email protected].