The wide acceptance of operational outsourcing among fund managers combined with the continued pressures to reduce fund expenses have led to an increasing preference for the multi-series trust (“series trust“) structure. In fact, they have become the operational model of choice for many fund managers making their first foray into the ’40 Act world, which makes sense – series trusts provide well-documented cost-savings and speed-to-market benefits. This turn-key solution allows fund managers the ability to focus on portfolio management and asset gathering rather than the myriad of operational tasks that can be associated with operating funds in the proprietary trust model.
While all of those benefits can be realized, they are based on one huge decision that many managers take for granted – choosing the right series trust. The increasing preference for series trusts has led to a proliferation of various trusts, created by service providers looking to capitalize on these opportunities. Unfortunately, there are far too many examples of fund managers that have not made the right choice of trust or service provider. Worse yet, there are plenty of fund managers who realize they chose the wrong series trust but don’t know how to make a move without encountering perceived significant headaches or costs.
To help fund managers who may be stuck in the wrong series trust, below are a few warning signs that may indicate you’ve made the wrong decision, followed by some action steps for making the move to a new provider a bit easier.
Warning Signs
Sales Process – This would be a fund manager’s earliest sign that the fit may not be right, and the good news is it’s probably not too late to change course and correct the problem. Many service providers have recognized the ease of operability for funds organized in their series trust. It makes it easier to implement an assembly-line methodology and build an impressive book of business with a favorable internal cost structure. With this in mind, many service providers often push clients toward the series trust model, without educating them on the different options available. While a series trust might be the right fit for many fund managers, it will not necessarily accommodate the business-specific needs of every fund manager. Look for a service provider that will give you an unbiased view of both the proprietary and series trust options, answer your questions candidly, and then leave the ultimate decision to the fund manager.
Consistent Error Rates – Accuracy should be the baseline expectation of a series trust provider. If a fund manager begins to consistently see errors in the calculation of the daily NAV, expense budget or accruals, those are signs that the service provider isn’t providing adequate resources for the series trust.Beyond that, if there is a pattern of consistently re-processing shareholder transactions and/or posting a lot of “as-of transactions,” it is likely the series trust provider is not performing effectively, much less adding value.
Board Competence and Focus– A strong competent board is a critical component of any mutual fund – a series trust is no different. A good fund manager wants a board that understands the investment strategy and the risks associated with it, one that asks tough questions and takes part in productive dialogues about its execution. If the board does not understand your investment strategy, your current series trust might not be a great fit. And while lack of understanding is bad, the absence of board interaction may even be worse. You want a board that is focused on your product and not overwhelmed with too many funds and/or fund managers to oversee. Limited direct interaction with the board often means there are too many fund managers in the trust, leaving fund managers to execute without the benefits of their wisdom. A good board is a necessity, not a formality, and if that function is falling short, the series trust is likely failing the fund manager.
Expense Allocation Methodology – One of the most sought-after benefits of a series trust is the ability to share many of the trust-level expenses. The concept that a trust comprised of many different series of funds commands better bargaining power and brings economies of scale is true and proven; however, many series trusts are not governed under an expense structure that is equitable for all funds in the trust. The series trust sponsor, and to some extent the Board of Trustees, usually negotiates fee arrangements with trust-level vendors, such as trust counsel, custodian, insurance broker, and even the trustees themselves. Many trusts will then allocate these expenses, which are often based on number of funds in the trust and/or total AUM, to the underlying funds based on their pro rata share of the assets. This means that your $1Bn domestic equity fund would be a paying a much larger share of the expenses than the more complex but smaller $10MM frontier market fund, which just happens to share the same trust.While helpful for smaller funds that are just starting out or have struggled to gain distribution, this subsidization of expenses by larger funds is often frustrating for fund managers that have been successful in raising assets. Fund managers should evaluate the expense allocation practices for any series trust being considered, and look for models that favor a straight-line or combination straight-line / pro rata methodology.
Fund Manager Exits – Fund manager retention can be a key indicator of the quality of a series trust. If the trust is losing fund managers and/or funds, it is not only a sign that things aren’t working, but it will likely lead to an increase in shared expenses as well. When that happens, fund managers have to be aware of whether or not their expenses are increasing disproportionately to their size. Keep in mind, fund managers may not just be exiting because they want to make a trust or service provider change – they may be closing unsuccessful funds.Series trusts and fund services providers should evaluate each manager thoroughly and ensure they are working with firms that have the expertise and resources to support a mutual fund. Frequent fund closures (also referred to as liquidations) can be a sign of lax due diligence by the series trust sponsor.
Slipping Service Levels – Service is an important but often hard-to-measure aspect of a series trust. If a fund manager notices an increase in response time to calls or a drop-off in proactive outreach, those are signs that a provider is overwhelmed or unwilling to act as a true business partner, which is a key attribute of a strong series trust. Slipping service levels can be the first sign of larger problems to come and fund managers should take them seriously and begin assessing their options immediately.
Action Steps
While many fund managers may see the warning signs of a faltering series trust relationship, few have an understanding of the steps it takes to make a seamless and painless transition to a new trust. Some specific action steps include:
Review the current agreement – The first step in a series trust transition is understanding the costs and commitment of the current series trust servicing agreement. The structure of client agreements varies from trust to trust; some favor a master agreement with individual addendums for each manager’s fund, or the trust may enter in a separate contract for each manager. A fund manager should have an attorney review the agreement to determine what, if any, issues/costs exist with exiting the trust early. With a clear understanding of the terms of the agreement, a fund manager can make an informed decision and begin to determine a timeline for potentially undertaking a conversion.
Start a dialogue with the board early – Before fund managers can move their fund(s) to another series trust they have to secure the approval of the board and the approval of the shareholders. It is important to begin a dialogue with the board early so they are aware of the fund manager’s intentions and they can work with them to get through the process in a timely manner that minimizes hassle. The board is also a voice for the shareholders so its buy-in is critical. The sooner the board dialogue begins, the less likely there will be any major stumbling blocks along the way.
Use service providers as a sounding board – Most fund managers are not operations experts, which is often why they choose a series trust in the first place. For that reason, it’s important to use expert service providers as sounding boards during a potential transition. Any credible service provider will have been through transitions before and can help identify important steps and potential pitfalls along the way. A conversion from one trust to another, whether converting to another series trust or a stand-alone trust structure, is commonly referred to as a reorganization, and is inherently more complex than a direct service provider conversion. Select a new service provider that will work with you to develop a thoughtful Plan of Reorganization and corresponding timeline that suits your unique requirements.
Weigh a standalone vs. series trust – Exiting one series trust does not mean a fund manager needs to go right into another. The fund manager should view the transition as an opportunity to look at their investment and business strategies and consider whether a stand-alone or series trust best meets their needs today and in the future. Perhaps some of the frustrations necessitating this transition were caused by the series trust model; while these pain points could have been specific to that trust, it could be indicative that a stand-alone trust is a better fit for your firm. Or, it may be that a fund manager has simply evolved beyond a series trust – growing too big or looking to launch additional funds that make a stand-alone trust the right model. A series trust will often look better from a cost standpoint but a fund manager has to weigh the savings of a series trust against the autonomy and flexibility that a stand-alone trust provides. No matter what decision a fund manager makes, it’s important to go through the exercise and understand the pros and cons of both options before committing to a new trust.
Conclusion
Series trusts offer a strong operational model that affords fund managers cost and efficiency advantages, but only if the fit is right. The business consequences of a poor series trust selection can be deleterious to the adviser’s strategy and hinder growth plans. When fund managers start to see the warning signs that they’ve made the wrong series trust choice, they can’t afford to wait. Operational inertia has been the undoing of many fund managers with strong investment approaches. If you know where to begin the transition process and partner with the right firm, a reorganization will not be as hard as you might think and could ultimately result in a superior operating model for your firm and its funds.
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