Does a 40 Act Make Sense? via Attain Capital
On the surface, it seems like a simple choice for Managed Futures managers to convert their private funds into a 40 Act Mutual Fund, especially with the explosion of assets over the last six or seven years. But that choice gets a little more difficult when you look at the current Managed Futures Mutual Fund space, and how much money is needed to break even.
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Does a 40 Act Make Sense?
It’s hard not to look at the chart below and think to yourself, where or how do I get involved?
If this is you, you’re not alone; as this is exactly the conversation being had over and over again in the managed futures space.
Managers are eyeing the trillions in mutual fund assets and hundreds of billions in alternatives growth against the rather lackluster growth in non-liquid channels and wondering when or if it makes sense for their firm to dive into the liquid alts pool.
We’ve worked with a handful of managers in converting their privately offered funds into mutual funds, as well as managers who started fresh and launched mutual funds with the dream of tapping the trillions of dollars that is invested via such channels.
We can say without a doubt there are wild success stories in the liquid alts space.But the question of when (and if) to do a liquid alts product (a so called ‘ 40 Act fund) isn’t as much of a slam dunk as you might think on the surface of it.
For starters, it’s starting to look like a Google or Uber-esque 40 Act winner takes all sort of business, with a whopping 45% of the $22bn in assets for the funds in Morningstar’s managed futures category belonging to AQR.
Further, 21 out of the 49 40 Act funds have less than $50m in assets, showing the smaller mutual funds are having trouble getting the necessary traction. And it’s not like you can just have a sub- $50m mutual fund sitting there forever.
Launching and running these 40 Act things is darn expensive, with hundreds of thousands in setup, operating, and legal fees, plus the costs of doing distribution.
We’ve heard anywhere from $25m to $50m in assets to break even just on the setup of 40 Act fund and ongoing costs of running it, and up to $200m to breakeven if rolling out a nationwide wholesaling team to distribute the product.
That may not sound so bad given all of the money in mutual funds, but it’s a different world than it was just a few years ago. One, just having a ticker and being exchange listed isn’t enough anymore to be listed on investment platforms like Scwhab, Fidelity or Wells or the like.
The explosion in liquid alts has resulted in the biggest broker dealers closing the gates, so to speak, to mirror more of the privately offered fund world – a ‘pay to play’ model where those funds which do the most revenue through the B/D get listed as available funds on their platform.
Sure, anybody can buy a mutual fund via etrade or a call into their broker – but these things are sold, not bought; as evidenced by the largest funds in the category having secured these broker dealer listings.
Two, the days of managers keeping their 2/20 in the mutual fund world, hidden inside of a swap through a controlled foreign corporation seem to be waning, with more and more funds going the route of hiring a CTA as a sub-adviser to the fund and the manager getting a split of the 1.25% to 2.5% fixed cost of the fund. That means revenues to the manager can be cut by 50% to 75%. Yikes.
So, faced with the prospect of making just a fraction of what they’re used to making – managers have to ask themselves if a mutual fund is really that much better at raising money. There’s a handful of mutual funds who would surely say so – but dozens of others who are likely to feel like they’re on the outside looking in.
Some try and have the best of both worlds by keeping some of their models in a 2/20 structure, while putting other models into liquid form at lower fee levels. It often sounds good, but can be tricky. What if the lower fee program outperforms and you cannibalise the higher fee product, for example?
Our back of the napkin math shows that a manager who returns 15% per year with $50m in AuM paying 2/20 needs $333m in assets from a mutual fund paying 75bps to generate the same revenue.
Do you think the average manager converting to a mutual will be more than six times better at raising money than the private fund? That’s the internal calculations going on around the industry.
But it’s a question that is mostly unanswerable for many managers without an in depth knowledge of the wholesaling and distribution game, and without a digital marketing platform geared to reaching tens of thousands.
The elephant in the (industry) room is that it’s not how well you perform. It’s not whether you have a mutual fund ticker. It’s not a great website or long history in the managed futures space.
Nope – in the mutual fund world, it’s a mix of the old school (the guy downing a cheeseburger on his way from a sales call in Kalamazoo to a sales call in Fort Wayne) and the new school (new age marketing teams dedicated to connecting to prospects you didn’t know existed from targeted educational marketing strategies,) that make the difference.
In the mutual fund world. Distribution is the name of the game.