Fund providers must be aware of the importance of structure for asset managers to deliver their respective expertise. When choosing a structure, review of the operational challenges and benefits for all the constituents may be an overlooked component in the process, particularly with the growth and advent of ETFs. There are specific operational nuances that help compound the thinking on why structure definitively matters for these potential fund providers.In today's investing landscape, anyone who holds out as a manager of assets has a variety of ways to distribute how they deliver that expertise to the market. From newsletters, to 40 Act funds, to 33/34 Act funds, to hedge funds, to separate accounts - there are a myriad of vehicles to choose from, and that selection matters more today than it has in years passed.
It matters more now because of the influx in options and the way information is consumed and how new ideas are adopted: via the internet, the 24/7 news cycle and the different social media channels with tools like Twitter that have changed the game. Each structure comes with different regulatory inputs along with its advantages and disadvantages.
THE PORTFOLIO MANAGER
As a newsletter provider, a portfolio manager who manages a model and is an idea provider can deliver their perspective with less regulatory oversight and fewer overheads. However, they also likely face less scalability for revenue growth, by not dealing with cash flows or the worry about disclosure of holdings. Newsletters are typically subscription-based and available to anyone that can locate these resources. For a separately managed account manager, there are technology and platform solutions that can help manage the daily cash flow needs of clients as well as the overall portfolio. The regulatory element for an SMA manager is typically just the SEC and doesn't fall under FINRA. However, gatekeeper access is needed to gain necessary distribution if one is accessing via financial intermediaries, and holdings are disclosed daily to the end client.
Hedge fund managers have a few more challenges with accredited investor requirements and more regulatory oversight than in the past. They have tools to help manage cash flows with more flexibility through lock-ups that most other structures don't possess. Gatekeeper access, or a good network of consultants to gain access to the institutional market, is needed here as well.
Where it gets very interesting operationally as it relates to structure is in the 40 Act space. For our purposes, we're going to focus on 40 Act ETFs and mutual funds. A portfolio manager for a mutual fund has to deal with the daily cash flows that come and go into a fund, and is sometimes forced to make changes that otherwise wouldn't occur, such as selling a position for a gain and realizing a tax consequence. Gatekeepers play an integral role in gaining access via selling agreements. Regulatory oversight is typically with both the SEC and FINRA and holdings are disclosed quarterly. For ETFs, a portfolio manager typically does not deal with daily cash flows due to the creation/redemption process inherent with their structure. Therefore, tax efficiencies, especially for active strategies can be far more beneficial in an ETF as long as the portfolio manager uses the available tools via the creation and redemption process. Gatekeepers play a less integral role, as most ETFs are available to anyone who has the ability to trade NYSE, NASDAQ or BATS listed securities globally. Regulatory oversight is typically with both the SEC and FINRA and holdings are disclosed daily.
For the advisor, most have built their practice with a particular business model over several years and operational knowhow. An advisor who is transactional-based is going to lean toward loaded mutual funds or unit investment trusts. An advisor who is fee-based is going to lean towards no-load mutual funds, SMAs or ETFs. An advisor in transition, that is from transactional to fee-based, has big decisions to make and can maintain an operational structure of supporting mutual funds and end of day trading, or converting their business to a vehicle that trades intra-day such as an ETF. ETFs now have active strategies, in addition to quantitative and index-based strategies, but can also present an operational challenge to how an advisor runs their business with components such as intra-day trading.
For the do-it-yourself retail investor, a model or newsletter that shares ideas on a particular asset class, security type, or strategy may otherwise be the best reception mechanism. For the owner of a mutual fund, shareholders activities in the fund will impact tax consequences. For an ETF owner, full transparency on holdings, and the benefits of the creation and redemption process tends affect other shareholder activities in a tax friendly way. All in all, structure matters and it influences portfolio managers, advisors and the end client for better or worse. As asset managers consider entering the packaged product space or distributing their products through intermediaries, additional factors should to be considered. Some features of each structure may benefit the asset manager, the end shareholder, the financial intermediary or all of the above.
James Carl is managing director of AdvisorShares.