Rising interest in hedge fund-like mutual funds among advisors and investors have driven service providers and fund managers alike to adjust their businesses to account for legal and tax ramifications of serving and operating alternative mutual funds.
Executives gathered last week at the Investment Company Intitute's 2012 Tax and Accounting Conference in Orlando to talk about best practices for dealing with these complex products. Money Management Executive spoke withTerry Gallagher, Executive Vice President atUMB Fund Servicesand moderator of the Operational Challenges Affecting the Treasurer's Office panel, which includedJoseph Kauten, treasurer,Waddell & ReedandIvy Funds,Dave Longhurst, treasurer,Dodge & Cox Funds,Amy Olmert, managing director,Legg MasonandJay Oprins, chief financial officer,Jackson National Asset Management, about how firms are looking to address issues surrounding complex products.
So what did the discussion center on?
A lot of our panel's discussion was focused on the increasing complexity of products, as derivatives become more commonplace in the portfolios. All of the panel members have created internal complex securities teams made up of people from accounting, admin, legal, compliance, tax, risk and even portfolio managers that get involved in product design and understanding the investments. UMB Fund Services, as a service provider, tries to partner with the advisor to help them better design the product they would like to offer.
Panel members also discussed the need to get involved and communicate among all areas of the firm. Everybody needs to be involved in the process, not just one group.
The panel also talked about risk management and about working closely with the compliance office and the risk group. For a long time, people have struggled with the difference between risk and compliance. And from the standpoint of the other panelists who represent their own fund groups, the risk side is involved in both portfolio analysis and policies and procedures.
We also spent some time talking about structure and the different ways that departments are set up. Some firms are set up functionally, with separate financial reporting, corporate action, and expense management teams. At UMB Fund Services we have our fund accountants and fund administrators work with funds on all aspects of the fund.
Our panel also talked about the limitations of these different structures, and how those with compartmentalized functions try to create opportunities for their associates to get involved in different projects or move between teams so they get a better understanding of the broader picture of everyone's responsibilities.
Describe the services your firm provides to mutual funds and what kinds of trends you are experiencing.
At UMB Fund Services, we do '40 Act mutual fund servicing, and we also have an alternative investment administration division, JD Clark. There's been a growing trend among hedge funds to become registered so that they're not subject to shareholder limitations. WhileJD Clarkdoes the hedge fund accounting for these registered funds, my mutual fund group works with them on the regulatory side. To enhance the servicing of these funds, we've also just announced the launch of a proprietary transfer agency platform for '40 Act alternative funds called ACE (Alternative Investment Communication Engine).
We still service a large number of traditional mutual funds, but since 2007 the mutual fund business has grown more on the non-traditional investment strategy side.
Talk about the amount of work you have to put in with alt funds versus traditional funds.
In a lot of cases, the rules are not 100% clear yet. Dodd-Frank has been out for a number of years and the regulators are still working through the various requirements. At the end of July, the SEC and CFTC came out with their definitions of swaps, and there are more rules coming out now that have defined some of the requirements and how derivatives are going to trade and settle. Derivative investments have to be looked at as to what needs to be reported, how much needs to be segregated for collateral purposes, and how to test for compliance. These are the complexities that everyone struggles with, as the rules have not necessarily kept up with the investments. As long as I've been doing this, and it's been 30 years, the investment community's creativity works faster than the rules do.
What do you advise your clients on?
In addition to a complex securities group, we have an accounting policy group that gets together when a new rule or regulation comes out and tries to work through the new requirements. We provide our clients with a quarterly industry update. We try to take a more operational focus to help our clients concentrate on what they need to do -whether it is the FATCA rule or pay to play.
What's the biggest challenge for alternative investment advisors looking to get into the mutual fund space?
From an operational standpoint, another challenge is educating managers coming from the hedge fund side on sales and advertising compliance for mutual funds. With FINRA, it's what kind of ads are okay and what the advisor can say in interviews and phone calls. Hedge fund managers are also not used to having custodians and accountants; they're used to dealing with prime brokers, so the communication and the timeliness of that communication is different.
We have an on-boarding checklist that we go through with new clients. For example, one of the things we need them to decide is their gain/loss methodology.
Partnering with our clients to advise and help them construct their fund is one of the more fun things that our group does.
Another of our challenges is that, as a service provider, we're had to reduce the ratio of funds to fund accountants over the last few years because of the increasing complexity of the funds. For example, instead of dealing with one custodian to reconcile, you might be dealing with multiple prime brokers and multiple accounts. So it's a complex world and we can't have accountants servicing as many funds as they once did.
What kind of advice would you give hedge funds looking to get into the '40 Act space?
Distribution, distribution, distribution. You have to figure out how you're going to market or sell your product. Who do you have a connection with and how are you going to get on the platforms to raise assets? We also work with them to help them understand the costs involved in distribution. Our goal, as always, is to help them succeed in what they're trying to do.