Gui Costin, Founder, Dakota
If you’re considering launching a mutual fund, there is a lot to work through before you take any initial steps. First, ask yourself: why do you want to launch the fund? A mutual fund is one separate account, so at scale it is a fabulous business for an investment management firm to have. However, if it's not at scale, or if it’s at a lower level of assets, it's a much more painful business, especially when it comes to breaking even.
However, If you manage an institutional quality, liquid investment strategy, a mutual fund is a user-friendly way for wealth managers to use to create portfolios for their clients. Whether it's an RIA, Bank, Broker Dealer, Institutional Consultant or a 401(k) plan, a mutual fund is a very easy vehicle to use. Separate accounts, LP’s, and CIT’s are not nearly as efficient or scalable for daily use. Mutual funds are also ideal for model-based investing, where daily NAV’s and daily liquidity are required.
My company, Dakota Funds Group is a 3rd party marketer for investment management firms, primarily selling mutual funds and separate accounts. Since our founding in 2006, we’ve raised over $30B for over 15 mutual funds. In this post, I’ll discuss some key elements to take into account if you’re considering launching a mutual fund.
Some of the primary questions I’ll be delving into are:
There are a few questions to ask at this stage. Namely: whether you should launch a fund yourself and become the Advisor, or fund a mutual fund company that will launch the fund for you, where you will become the sub-advisor. These mutual fund firms like Harbor, AMG, John Hancock, etc. have big distributions that you can leverage.
If you decide that you are committed to launching a fund of your own, you’ll need to think about how to create it from a structural standpoint. This brings us to the second question:
The first thing you need to think through is whether you go into a Series Trust or create your own mutual fund series trust. To make it an easy decision, value in a mutual fund is created at the investment management level by generating great performance, and at the sales and marketing level by raising a lot of capital. There is no value added at the series trust level or the mutual fund board level. Since it’s a mutual fund, which means that it's mutually owned by the shareholders and governed by an independent set of directors. When the going gets tough, having some friendly board members won’t really do you any good.
So, if you are starting from scratch with your first fund, I would recommend going into a series trust. We have provided a list with contact information here to help you get started.
A lot is changing in our industry. Passive is eating active’s assets, literally. Which means fees are coming down and fee pressure is everywhere. When thinking about pricing your fund, my recommendation is to price it to be bought. Do not price it where the price will prohibit a conversation with a professional buyer. In equities, fixed income, and alternatives, that would mean a total expense ratio of 1.00% or lower, or an expense cap of 1.00%. Pricing anything over 1.00% is going to knock you out of many conversations almost immediately, and reduce your total addressable market. Many alternative mutual funds have priced themselves at the 1.99%, and in some cases above 2.00%, which unless you do something special, will make the fund a persona non grata. Some alternative mutual funds can get away with 1.25% or 1.35%, but these are few and far between. If you are going to cite AQR and their pricing, don’t. It's not a fair comparison as they have performed and have been in the mutual fund business since 2006.
To cite an Institutional Share Class example, many of the firms we work with put their management fee at 1.00%, and their expense cap at 1.00% with the other component, administrative expenses, running in the range of .12 to .20 basis points. As the fund grows, the administrative expense comes down and those savings accrue to the management fee.
As far as the management fee for active, somewhat concentrated equities, 1.00% still works. For fixed income, .50% to .75% is on the high end. For alternatives, my opinion is to price day one at an attractive rate (1.00%) and grow the assets more quickly at a lower fee level rather than holding out for the last basis point and staying at a low asset level. I would use attractive pricing as a competitive advantage.
Do you have an internal salesforce or do you plan on hiring a third party marketer, or do you plan on investing and building out an internal team?
Once you've launched your fund, you typically have a short track record, a low asset base, and are selling a new product to a new set of buyers.
(Note: There are exceptions to this, especially if you’ve converted an existing Limited Partnership, which you can do if you convert the whole fund into a mutual fund. It gives you that track record and the assets in the LP. One other key exception would be if you have been selling your strategy in a separate account format to your targeted channel, which would potentially reduce the sales cycle time.)
The only real place you can start selling your fund is to RIA’s via Schwab, Fidelity, TD Ameritrade and Pershing. Why? Because the RIAs have discretion, and are not tied to an asset level (“We need the fund to be $100M before investing,”) or a track record threshold (“We need a three-year track record before investing”). RIAs can do whatever they want to. This requires you to know the RIAS, who are scattered in 60 cities across the country, and to be on one of the platforms.
How long does it take to get on these platforms? It depends. Schwab may take three to four months or more today. Fidelity, as of the last couple of years, needs an RIA to you, and will commit to a certain asset level once approved on the platform. Fidelity is very hard to get onto, while TD has been a little more problematic, but typically takes anywhere from three to six months. Pershing is a little easier in the 4 two to four month range.
Our network of over 1,500 RIAs primarily custody at Schwab and Fidelity, so for us, getting on those platforms is the key. TD and Pershing, while great platforms, tend to have smaller RIA’s, sub $100M.
The sales, marketing and distribution plan should be to call on the firms that buy what you sell regardless of what platform you are on. The firms that should be your target buyer on day one are RIAs. You don't have to be on any supermarket platform to start selling. For us at Dakota, one big advantage is that many sales people and leaders of firms believe that you must be on a platform to make a sales call (exception: MS, ML, UBS and Wells Fargo). However, once your mutual fund is live, you must start calling on RIAs because they can invest in a small fund with a short track record. Don’t worry about whether you are on Schwab, Fidelity TD or Pershing. Just go sell. Put the selling agreement process on a parallel track.
The RIAs channel is great because they are thoughtful, long-term investors with investment committees and detailed investment processes. They are slow to hire and slow to fire. The typical sales cycle is between nine and thirty-six months. The good news is that RIAs are growing extremely quickly. However, the bad news is that they are spread out across the country, making the distribution inefficient and expensive. It helps to have a more institutional-type sales person calling on the channel rather than a fact sheet, performance selling wholesaler. Not that the latter are bad people, but the RIAs don’t have time to waste, and want real insight on how an investment manager thinks and makes investment decisions; they can read performance numbers themselves.
If you can successfully cover the RIAs in the first one to two years of your fund’s life, you can simultaneously call on the Bank and Independent Broker Dealers, who create models and select lists, which are the Holy Grail for any mutual fund. With the Bank and IBDs, you have requirements to get over so the timing is pushed out, but getting ahead of the game is a good idea, especially if your strategy is performing and has a good story. Eventually, you will surpass those requirements and you want to be deep in a sales cycle with those firms when you do pass the thresholds.
To recap the sales plan: Cover the RIAs immediately (or even before you launch your fund with your separate account strategy); work on the Schwab, Fidelity, TD, Pershing selling agreements; and then cover the Banks and IBDs with the anticipation of getting to a three year track record at a asset level about $75M.
Once you’ve thought through all of these questions and established a plan, it’s time to get to work. For more on RIAs, you can check out some of our top 10 RIAs by city.