Broker-dealer and custodial platforms are putting up higher gates for new funds to gain access to advisors, spurred by intensified competition and increasing regulation.
In a Q&A with Money Management Executive, Andrew Rogers, CEO of Gemini Fund Services, a mutual fund administrator, discusses the reasons for these hurdles and what providers are doing to surpass them.
Q: Registered investment advisors are clearly on the up and up. How is the growth of the sector exerting pressure on how ETFs and mutual funds are distributed and marketed?
It's been a great thing for mutual funds in particular. The custodial platforms are the first platform they gain access to. The growth of the RIA community makes newer funds more accessible. The way mutual fund and ETF providers position the funds and the distribution materials they have must be customized for RIAs. Marketing materials are also positioned differently.
Q: Broker-dealer platforms are putting up higher gates for new funds to gain access to advisors. What are the reasons for those hurdles?
We work with investment advisors on funds to assist them in gaining access to broker dealer platforms. If they don't gain access, they can't raise money because almost all money these days come from third party intermediaries. They're having trouble because custodial platforms are trying to limit the number of new funds. They want to make sure funds that gain access are able to raise assets. They're not willing to take a chance as much as they were before.
The custodial platforms are also adding barriers to entry, making sure there is significant demand before they accept funds onto their platform.
Q: What are providers doing to surpass those hurdles?
Education is primary. We must teach advisors what requirements are so we can set expectations. We schedule meetings with advisors. We also create gatekeeper conferences so they can meet our clients and be actively persistent.
Q: What are you doing at your firm to bring in fresh, new talent at a time when there is distrust of Wall Street?
This is been a great time for Gemini. A lot of Wall Street people live in Long Island and commute. We've attracted from Wall Street firms for people who want a different lifestyle. We cater to talent who used to work in New York City who have been displaced because of changes in the market. We had 100 people three years ago, and now we have 225 people.
Q: Providers are grappling with uncertain compliance rules surrounding leverage. How are providers overcoming this? Why is there such uncertainty?
The new generation of mutual funds is moving away from directionally long equity and bond funds. The mutual funds of tomorrow are increasingly alternative asset classes, low correlation to the equity indexes, and manage downside risk. These mutual funds are increasingly using derivatives to gain access to alternative investments and many of the derivatives have embedded leverage based on notional exposure. The compliance rules for leverage have traditionally focused around actual borrowing and funds are limited to borrowing 33% of assets. However, traditional borrowing is generally a portion of a mutual funds' ability to have leverage within a mutual fund.
A mutual fund can use futures, options, swaps, leveraged ETFs, and other instruments to gain greater exposure. The amount of collateral coverage may be based on settlement terms of the derivatives. Service providers have developed policies and procedures to coverage for borrowing, leverage, and collateral requirements.
However, many of the rules implemented are not covered in the rules and are based on interpretations based on industry experience. Some trust's may have different procedures and policies and the service provider will have to customize the compliance program based on client's requirements. The service provider will provide industry guidance, but there may be slight differences in testing requirements.
Q: Name and describe in detail two additional operational pain-points mutual fund providers are facing today.
Some pain points that service providers are facing today are from the growth of multi-strategy funds. There is a growing requirement to provide portfolio statistical information by sub-advisors and strategies. A single mutual fund may have 20 or more strategies. Advisors are looking to service providers for more than fund NAV and compliance testing.
The advisors are seeking risk and compliance metrics by strategy and sub-advisor. In addition, they are seeking more complex attribution reporting by security and strategy.
The requests are also coming from fund boards, seeking greater attribution reporting as reviewing just performance with complex mutual funds provides incomplete information.
Boards are increasingly looking at volatility and down side risk management as required information in the review process. The service provider must provide greater reporting functionality that integrates back office with middle office.
Q: How have complex instruments placed more stresses on fair valuation?
Complex instruments have caused more stresses on fair valuation. Funds are increasingly investing in private loans, private REITS, hedge fund, swaps, and other alternative instruments. Many of these securities are not traded on exchanges. The service provider is working with the advisor to create pricing methodologies to value these instruments. The process must be documented and reported through the fair valuation process. The service provider is expected to be an expert and provide guidance in valuation and documentation.
Q: In what ways have fund providers developed procedures to monitor fair valuation?
Service providers have developed many procedures to monitor fair valuation. Some of these procedures include back testing which includes price comparison to disposition of securities and comparing pricing estimates to actual prices. Service providers are using multiple pricing services to compare prices. In some cases, service providers are hiring consultants.
Q: Describe an operational challenge your firm experienced recently and how you overcame it.
There have been many distribution issues the past few years. One issue has been custodial platforms are increasing requirements for funds being added. The custodial platforms are important for distribution to RIAs and many broker dealers clear through the platforms. Custodial platforms are increasing looking for minimum assets and demand on the platforms. In addition, many large broker dealer platforms are seeking large fees to be added to the platform. In addition, they may have large ongoing minimums that may make the broker dealer platform unprofitable in the initial years. The larger broker dealer platforms are becoming increasingly difficult to gain access to. Service providers are increasingly providing key accounts support to help funds gain access to custodial platforms and broker dealers.
