Blake Darcy had never set up a mutual fund.
But the progenitor of the DLJ Direct online brokerage was trying to import the principles of value investing propounded by Columbia University Adjunct Professor Joel Greenblatt into two domestic and two international no-load stock funds being established by Gotham Asset Management.
He decided that Gotham's strengths lay in its approach to investing and it had to concentrate on successful stock choices, if the funds were to succeed.
Account opening and back office processes?
These he could contract out and, in theory, let an outfit with more experience in the field take the headaches of administration off his hands.
So Gotham hired BNY Mellon Asset Servicing to provide fund accounting and administration, custody, transfer agency and other services, as it launched its four Formula Investing funds last year.
Here's what Darcy learned about outsourcing the administration behind the management of mutual funds.
The Magic Formula
Greenblatt is the creator of a "magic formula" that he has said would have achieved 30.8% annual returns, on average, for investors that applied it from 1988 to 2004.
Indeed, his Gotham Capital hedge fund said it earned a 50% annual return using the formula from 1985 to 1995.
He later authored "The Little Book That Beats the Market," which became a New York Times bestseller.
The book explained his tactics for screening stocks, which is based on the rather straightforward idea of buying good businesses on the cheap.
The "formula" ranks companies on return on capital and earnings yield, marries the two and then picks the top of the heap that remains.
In October 2009 he launched Formula Investing, an online money management firm that follows the investment strategy described in his book. And in 2010, he, Robert Goldstein and Gotham Asset Management launched four funds based on the "magic formula," under the Formula Investing Funds brand.
For this, Darcy interviewed a handful of service providers that have strong track records in mutual fund administration and, in the end, chose BNY Mellon Asset Servicing and its FundVantage Trust product.
Do's
Figure Out What Your Core Strength Is, First. Darcy early on decided that what Gotham was best at and should concentrate on was the investing of customers' funds, servicing the customers accounts and, in general, managing the relationships with customers.
That meant, in turn, keeping day-to-day operations as simple as possible. That, in turn, ultimately meant outsourcing all facets of administration.
Stick to Your Guns. Early on, Gotham looked at different aspects of administration that might make sense to develop and manage in-house. One that got serious consideration was how to configure and provide controls for the funds' board of directors to oversee performance.
Ultimately, the company decided that, because the mutual fund world is highly regulated and communications between directors and managers closely watched, not to do this. Instead, it made sense to use a system that already had proven controls and means of keeping track of communications.
Find a Service Firm that Wants to Serve You. Different firms have different levels of interest in delivering on the promise of strong service. In his interviews, Darcy got the sense that some firms just wanted the business.
He wanted, instead, a firm that wanted to really get to know Gotham's approach. In meetings, he constantly looked for participants who understood not just the mutual fund business, but specifically what Gotham was trying to do with the Formula Investing funds.
He looked for participants who clearly did their homework and who got excited about what Gotham was trying to accomplish.
Find a Service Firm with Flexibility. Gotham had never set up a mutual fund. Gotham had never operated a mutual fund. There was no guarantee that it could produce 30% or 50% returns. Or attract investment in the first place, since Bernie Madoff and his 12% returns had proven to be a fraud.
So Darcy looked for and got flexibility on the pricing of fees from BNY Mellon Asset Servicing. Fees start at reduced prices and graduate over time, as the business grows.
Look for Availability. When BNY Mellon started to set up its system, its project managers held weekly meetings with Gotham point people. That is now down to roughly monthly meetings. But the key in the entire process is this, Darcy said: Who is available when you need them? Can you get on the phone the outsourcer's point person, when a problem needs to be resolved? And can the person make the needed decision, at that moment?
Look for More than Adminstrative Help. With BNY Mellon, Gotham got more than help with understanding the mutual fund market from an experience player. It got help in distributing its funds.
Now, if you go to the Formula Investing Funds site and try to purchase funds, you get redirected to the mutual fund distributor of your choice, from Charles Schwab to E*Trade to Folio Investing. At each of those sites, the four Formula Investing funds pop up and the customer checks off which will be invested in and how much.
Don't's
Don't Underestimate the Help You Will Need. Gotham understood it knew nothing about how to operate a mutual fund and needed help-and a lot- of handholding-from someone who did.
That meant looking for a firm that was very organized about how to roll out and administer a fund and knew what details could get bollixed up.
Don't Underestimate the Work You Will Still Need to Do. Gotham Asset Management underestimated the amount of reports that would have to be produced, from risk-return summaries on down. It had to hire a new staff person.
"The only issue was we should have asked a few more questions about the ongoing requirements of the business," said Darcy. "That would have helped in resource allocation.''
Don't Feel Obligated to the Outsourcer. Don't hesitate to consider bringing the administration in-house, when you're ready. And let the outsourcer know, upfront, you'll be expecting assistance in that, when the day comes.
