On December 27, 2010, our advisory firm opened a new mutual fund, the Geier Strategic Total Return Fund (GAMTX). Because many of my fellow advisors have also contemplated creating and managing their own fund, I'm invariably asked about how we did it, and why. They ask under the assumption that opening up a fund is an expensive, disruptive and risky undertaking, so they are curious to hear about the experience.
Here's my attempt at answering some of these questions.
We started to seriously think about starting a new fund in 2007. The need for such a fund was arising on several fronts. For example, many of our clients in the 55-to-65 age group had substantial assets accumulated in employer 401(k)s and we were having difficulty finding suitable subaccounts to transition these assets from an accumulation- to distribution-oriented portfolio. We were looking for actively managed funds with an absolute return emphasis, but few were available.
We also thought starting a fund would help us deal with the classic dilemma faced by any advisor with high-net-worth clients: how to deal with referrals-friends and relatives of existing clients-whose assets were not at a high enough level to warrant paying for our comprehensive services. A fund would provide a vehicle to establish a relationship with these people. It would also allow us to take our strategy, which up to then had been used for an exclusive circle of high-net-worth clients, and open it up to mainstream investors-schoolteachers, policemen, firemen, etc.
We've also met many prospects who have been interested in our conservative growth strategies, but are very happy with their current advisor. A mutual fund offered a convenient way for such clients to have us manage some of their assets, while maintaining the relationship with their current advisor.
Once we decided to go forward, one of the first things we had to do was ask ourselves if we have what it takes to create and run a mutual fund. It is one thing to manage an advisory firm, but quite another to start a fund from scratch and make it successful. What qualities are needed to do so and do we possess them? To find the answers, we digested any information we could find on small funds that had started up over the last 10 years, trying to identify the traits that were shared by those that were most successful.
One of the most important factors in establishing a successful mutual fund, we found, was having sufficient financial resources because, yes, starting a fund is expensive. The startup costs alone can run over $50,000. These expenses include attorney and other consultant fees, statutory fees such as "blue sky" registrations in every state where the fund will be offered, printing of the prospectus and the creation of Web sites and other branding necessities.
It was also important to limit costs, because we knew that for a fund to be successful it not only had to perform well, but also had to have low expenses. We wanted to keep our expense ratio competitive, so keeping the fund's operating expenses in line was an important goal. One of our first major decisions along these lines was to join an existing trust, rather than create our own, so administrative expenses would be shared among other funds.
We found other areas where we could cut costs. Rather than shop for our own legal, audit and transfer agent, for example, we opted for a turnkey service provider that could help us through the process of establishing the fund and minimize the disruption to our existing advisory practice. It took about six months to find, interview and decide on a service provider that best fit our needs.
It is extremely important to understand in which areas your turnkey provider functions best. Make sure you know when they will be holding your hand and guiding you, and when you are on your own. Having an open relationship and strong connection with them is crucial so you can discuss shareholder and fund-related issues.
A Question Of Size, Style
One of our greatest challenges was estimating the initial amount of assets that we would be able to place into the fund. Our research showed that anything less than $15 million to $20 million was problematic. All service providers have minimums that they charge for administration, custody, legal, etc. The fund could absorb all of those fees, but the expense ratio for a fund with under $20 million in assets would be exorbitant and no sane investor would buy the fund. Therefore, our firm would have to waive any fees over a completive amount. We wanted to keep the fund expense ratio under 2%. Forecasting the initial net assets, as well as the quarterly and annual expected growth at various expense levels over many years, required quite a few Excel spreadsheet "what if" iterations. In the end, we decided the fund needed to exceed $20 million in assets.
Another important factor to consider for managing a successful fund is finding a viable investment strategy. It takes three years of performance just to get your first star rating from Morningstar. Having a proven, consistent investment process is key. Our advisory firm has managed a conservative, long-term, absolute-return strategy for the last 10 years that has never had a down year and averaged around 6% net annually. This strategy-which emphasizes low-risk, long-term growth through income and capital appreciation-is the same one we are using in our mutual fund. The fund's conservative growth objective and absolute return focus, which strives for positive returns regardless of market conditions, is designed to meet the needs of today's investors, especially baby boomers who are nearing retirement. Their accumulation years are winding down. They will need some growth over a hopefully long retirement, but do not want to carry the type of risk that could expose them to a collapse like the one in 2008. By catering to this group of investors, we felt the fund could be a success.
There were other start-up ramifications we had to consider, such as severing a valued, long-term relationship with our broker-dealer. We had been a hybrid fee and commission firm. The commission slice of our advisory revenue has historically been minimal, but we always wanted to be able to offer our clients variable products with which we were comfortable, when needed. As required by Finra, the broker-dealer supervised our fee-based advisory practice as well as the commission business that flowed through them. In our discussions with them regarding establishing our own 40 Act fund, they informed us that they would not want to expose themselves to the additional burden of supervising the fund. Eventually, we concluded that we would need to forgo our commission revenue in order to open the fund and become a fee-only RIA.
Impact On Employees
One of our greatest concerns entering this endeavor was how the additional workload would impact our employees. Mutual fund administration, including daily reconciliation and reports, is an entirely different ballgame than what goes on in an advisory practice. A mutual fund "shareholder" has many different characteristics than an advisory practice "client." They have differing wants and needs. Who in our organization would now receive shareholder phone calls? What information would be needed to answer shareholder questions? We needed to work through how we would adjust our processes, decide on any new hires, and train our employees to successfully manage the new duties.
Also, we had to consider what new compliance requirements to expect. Because of our broker-dealer relationship, we were already very familiar with Finra rules and regulations and had them built into our procedures. Yet we knew that a mutual fund has its own regulations and we needed to learn what they were and how to administer them properly. We did make mistakes along the way. For example, because of an error that was caught by our compliance officer, we had to revise our first quarter fund fact sheet to remove our Morningstar ranking. We did not know that a fund needed to be in place for a year before rankings could be published.