Three managers and two industry experts recently shared their observations about starting and managing liquid alt funds at Infovest21’s “Key Considerations in Launching a Liquid Alt Fund”.
Skyview Investment Advisors‘ Larry Chiarello advice: “Be flexible on the time line. If you think it will take 18 months, it will be more like 34 months. If you think it will cost X, It will be Y. If Plan A doesn’t work, have a Plan B….It’s not a linear decision tree but a feedback loop.”
For Chiarello, the first question is do we belong in this business? Are we committed? Liquid alts are not for everyone.
The second major decision is what strategy to offer. “My first inclination in 2010 was to do a global macro fund. However, many investors won’t understand what global macro is and it would therefore be hard to sell. So we went with long/short equity for our first fund. The positives of long/short equity are that it uses little leverage, doesn’t high turnover, uses small cap/mid cap, and it fits well in the ’40 Act space,” commented Chiarello. “Convert arb and managed futures don’t fit as neatly. Keep it simple!”
Dane Czaplicki of Long Short Advisors agrees that long/short equity belongs in the ’40 Act space especially if there is no leverage or derivatives. “It is something that investors understand. The majority of long/short equity hedge funds already meet ’40 Act restrictions, which is why there is so much fee pressure on the 2/20 model for these vanilla strategies.“
Bob Dorsey, co-founder and managing director of Ultimus Fund Solutions, agrees that not every strategy fits an open-ended fund. “Long/short, market neutral, multi-manager, managed futures, and funds of funds are the main strategies. Think about the strategy costs – the costs to run the fund e.g. advisory, custody etc. Some strategies fit well. Others don’t because of the strategy costs.”
Some strategies are expensive. “The SEC has made some of those expenses part of the expense table. You need to be able to explain to the financial planner that it is different from an operating expense. There is more to it than a management fee and operation expense. The fund accounting expense and custody expense is high. Those expenses impact the operating cost,” adds Dorsey.
Another major issue is which structure to use. Chiarello said they went with the series trust with the idea of moving to stand-alone as they got bigger.
Czaplicki is an advocate of the advisor/sub-advisor route. “The fund provides a template of what long/short equity managers will look like in three to five years. The advisor/sub-advisor route takes a lot of onus off the money manager. As the advisor, we focus on the operational aspects of running the fund company, leaving them to focus entirely on investing on our client’s behalf.”
Czaplicki emphasizes the need to have good partners whether it is advisor/sub-advisor or vendors such as custodian, prime broker and administrator.
“When you launch a mutual fund, treat it like a business not just a product,” suggests Dorsey. Develop a five-year strategic business plan for the product and make sure to execute against the plan. Be sure to have the right partners in place to execute the business plan.”
Fees are another big issue. Performance fees aren’t allowed in a mutual fund but fulcrum fees are. Many hedge fund managers explore the concept. As an example, if the management fee is 1%, the fulcrum fee could go to 2% or down to 0%. Sometimes the increment is 25 basis points up and down, 50 basis points up and down.
“While permitted, our experience is the SEC doesn’t seem to like them. They can be difficult to calculate. Fund advisers find them hard to explain to some financial planners and advisers as a result of the required fee disclosure,” observes Dorsey.
Czaplicki said they looked at fulcrum fees and decided not to do it. “We settled on keeping things simple.“
Fee compression isn’t going away. Single manager funds have to come in under 2.0% while multi-manager fees have fallen over the past twelve months from as much as 3.0% to as little as 2.3%, observes Czaplicki. “No one will get away with more than 2% for long. With a single manager fund, the investment manager can control fees while in a multi-manager format they are at the mercy of the advisor/fund of funds.”
Czaplicki says they have seen multi-manager funds raise a lot of assets initially, but none has been able to sustain the growth. The investor is increasingly getting more educated and is weighing the pros/cons of fees versus performance. “Over time,” he says, “they will have more comfort with single manager funds which have lower fees as well as better performance than their multi-manager counterparts.”
Coming Soon – Part 2: Platforms, Distribution and Cannibalization