Can Launching a Mutual Fund Help an Advisor Boost Managed Assets?

Start-up Guru Jeff Provence Offers Tips on What an Advisor Must Know Before Getting Started

Within the next few months wealth managers and advisors will consider new ideas and strategies for attracting new clients for 2010 and beyond.  Many will turn to campaigns such as direct mail, email marketing, sponsoring sporting events, and cultivating referrals.  However, others whose clients may have been more deeply impacted by the crunch of the meltdown will consider recovery of lost business by moving downstream by attracting smaller investors.

In this report, The Trust Advisor found that advisors can:

  • Can Start a Mutual Fund for as Little as $35,000
  • Begin to be Profitable with $8 million in the Fund
  • Buy the Management Rights of an Existing $10 million Fund for $350,000

For my report, we interviewed key players in the field who offer proven perspectives on this traditional strategy.  This included: a firm that specializes in turnkey operations; a successful advisor who launched his own fund in 2004; and a valuation specialist who offers his own unique viewpoint on whether to start a fund from scratch or simply acquire one.

Mutual funds are part of America's investment fund marketplace. The landscape includes SEC unregistered funds, such as hedge funds and private placements. It also includes common trust funds,  a $3 trillion market alone which The Trust Advisor will cover next week. But, our focus this week is becoming part of the 8500 SEC registered funds or better known as mutual funds consisting of a $12 trillion target marketplace.

The benefits of starting a mutual fund are compelling:

  • Attract Smaller Investors.  Private-managed accounts cater to large investors.  The cost of keeping small investors is prohibitive.  By launching a fund an investor can participate in the strategies of the advisor for amounts as low as $5,000.
  • Easier Target Market to Reach.  Investors are hard to reach.  The cost of marketing directly to the client or the investor is heavy and requires building a longstanding relationship.  By selling to an advisor you reach the investor directly.  You reach the investor through the advisor which builds brand awareness and loyalty to a potential fund family.
  • Lower Marketing Costs.  Advisors can be reached through wholesalers or through direct email marketing which permits the creation of marketing channels that are reasonable and economical and paid for out of the load of the mutual fund.  The spin-off potential of building those distribution channels can be significant.
  • Cross-Selling Opportunities.  Once a mutual fund or a family is created, an advisor can harvest its mutual fund client base for other products or services and provide unique ways to involve the advisor in the process.
  • Low Start-up Cost. Start-up costs can run as low as $35,000 and can yield asset bases of $50 million or more after several years.

The Investment Company Institute or ICI is the industry association. The ICI publishes industry statistics and provides a great deal of investor education.

I interviewed Jeff Provence who runs Premier Fund Solutions, Inc near San Diego California.  He isn't your typical fund consultant.  He set out 11 years ago to offer advisors a turnkey service for those who are interested in launching a mutual fund.  Provence has built a string of successes that has helped advisors bring more than 20 mutual funds to market from around the country.

Provence says that beginners should keep it simple.  He says that the Investment Company Act of 1940 provides for a straight and simple way to adapt any core strategy and turn it into a mutual fund capable of bringing in small to medium size investors.  Core strategies include large cap, small cap, medium cap, growth or value-oriented approaches.

Since all purchases and sales of securities in a mutual fund are done on a cash basis and all securities are typically held with a bank custodian, there is no leverage involved.  He says borrowing can be involved but it must work outside the account using special arrangements.

Provence adds that mutual funds that tend to do best adopt strategies that appeal to large mass audiences.  Strategies that most investors can't understand like options and going short appeal to smaller audiences and therefore are less likely to attract investors.  Provence says that an advisor should have a well-defined action plan and a strong sense of the costs to support the structure.  I asked him what amount of assets under management an advisor must have in order to consider transitioning some of his existing investors into a fund.

Surprisingly, he says it takes only $7.5 million of assets under management with a load of 175 basis points or 1.75 percent to break even.  After that a fund can be made profitable.  Therefore an advisor with at least $100 million of assets under management can clearly begin their own mutual fund simply by arranging a transition effort to the fund with a minimum start-up of $8 million.

Provence charges between $35,000 and $40,000 to go through the process.  This includes filing the prospectus with the SEC, going through the legals, setting up the policies and procedures, writing the prospectus and arranging for the accounting and custody.  That fee includes the attorney's fees. U.S. Bank Fund Services told us this week they charge between $60,000 and $100,000 for the same service. Provence says that you can expect the ongoing maintenance costs to run between $120,000 to $125,000 minimum on an annual basis to launch a fund. More details are available on his website:

Satisfied Client

One of Provence’s successful and outspoken clients is Canadian-born Paul Frank. Frank is the solo operator of New York based ETF Market Opportunity Fund, "ETFOX." ETFOX is a fund of ETF funds. Frank launched the fund in 2004 with mere token investors of $100,000 and after six years has grown it to $58.9 million.  His performance and handling of his large growth cap fund has earned him a 4‑star Morningstar rating.

Given that most funds lost 30 percent or more of their value in 2008, his ETFOX’s lackluster performance last year put him at the top of his group, permitting him to retain his champion rating.   Frank's pragmatism seems to strike a chord with the industry in that, in spite of the fact that he only lost 23 percent last year in fund value, he is in a category called “one of the least of the losers.”

Frank says that this is not a business where if you build it they will come.  "It will take hard work and cultivation in order to bring the business in."

Morningstar has a three-year performance requirement in order to get rated on its service.  Frank added that just because you are on Morningstar or Lipper doesn't mean that investors will come to you.  You need to go out there "and bring in the investors".

To do that he has his fund listed on Schwab's platform which charges him 40 basis points out of his operating expense just for Schwab to handle his transactions.  Given that his management fee is 175 basis points; his no-load fund still makes money in spite of what he pays distributors.  In addition he has recently hired a group of wholesalers to promote the fund to advisors.  They too are paid fees out of the load, which can eat up some of the profits.

Launch #2

Frank has done so well that he has retained Jeff Provence once again to establish an international fund which is set to launch in January.  Given ETFOX's success he feels reasonably confident that his international fund will be a success.  But he adds, "no one knows for sure until the check has clears the bank.”

He encourages others to get involved in it, but suggests they make certain that they have thought the process with care.  He recommends that advisors contact somebody like Provence who can put all the pieces together.

Are Acquisitions Better? 

I asked Frank whether it would have been better to have acquired a fund rather than start his own.  He said that if you're starting from scratch it's probably better to start your own because the cost of acquisition may be prohibitive.  He says that in today's market the cost to acquire the management rights to a mutual fund can run two to three times the fund's gross revenue.  It can also depend on the fund's performance.  He adds, "if the fund had a poor track record it would not get a great price."

Frank's estimates as to what a fund might go for in the open market were corroborated by both Provence and an executive at U.S. Bank Fund Services.  For example, the fund with $10 million of shareholder assets which has a mediocre growth record would probably sell at a multiple of two times gross earnings. For example, if the load is 175 basis points or 1.75 percent, then the value of the fund if bought or sold by another management company would be 175 basis points multiplied by the asset base of $10 million, which comes to $350,000.

I spoke to Jon C. Walls, a financial analyst and former Lehman Brothers' investment banker, about whether it would be advisable to start one’s own or buy a fund with these low valuation multiples caused by a depressed market.

Walls said that if a relatively small fund were offered with approximately $10 million under management for two times an expense ratio of 175 basis points, it could make more economic sense to buy a fund than to start your own. The value of being able to control a $10 million asset base and the requisite fund management infrastructure all while avoiding the hurdles of a start‐up for a mere $350,000 is compelling and reasonable, assuming the fund is of a reasonable quality and the investor base can be retained.

Fund management company transactions are difficult to find on the Internet or from most reporting services.  SNL Financial, which tracks these transactions, has reported about 15 transactions in the last year. There is no comparable sales history. It essentially is a workout process when it comes to determining how much to pay for a mutual fund management rights, based on the principle of multiples of gross revenue of the acquiring fund.

Philadelphia Fund Moves to Dallas

Shareholders today (November 6) of the Philadelphia Fund (PHILX) have approved the acquisition of their fund into Dallas based Westwood Group's WHG Large Cap Value Institutional Fund (WHGLX). The transaction will be able to boost the Westwood’s fund's $131.3 million asset base by $53.6 million immediately. Although the specific terms and conditions of the merger were not disclosed in the proxy statements, industry experts believe that Westwood may have paid as much as $2 million in WHG stock for the fund.

As a growth strategy for most advisory firms launching a mutual fund or a series of them, this seems a logical action. It's actually hard to find a wealth management organization with a $1 billion AUM that does not have one or two mutual fund properties under its roof.  Benefits include increasing the shareholder base so that investors will now appreciate the advisor and his other strategies while making the adviser aware of the brand name.  Plus there is the referral potential of having smaller investors taking notice of the name of the fund family.

Jerry Cooper, senior editor, The Trust Advisor Blog. Steven Maimes contributed to the research.



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