Launching a Mutual Fund

Launching a ’40 Act mutual fund can significantly expand an adviser’s business while broadening their product solutions footprint. When considering starting a mutual fund, there are many key variables to keep in mind, such as the timeline, structure, costs, marketing, distribution and regulatory requirements.

Could launching a mutual fund be the right move for your business? For your benefit, we have outlined below what it takes to launch a successful mutual fund and the fundamental elements involved.

 

GROUNDWORK FOR LAUNCHING A MUTUAL FUND

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Does it Fit? Will Launching a Mutual Fund fit into your business plan?

From distribution opportunities to reduced transaction costs, there are many benefits that advisers can derive from offering one or more of their strategies in mutual funds to grow their product line and assets under management. When an adviser considers expanding their product line by launching a ’40 Act fund, there are questions to help determine if this is the right direction:

  • Is there additional demand for business today?
  • Are there more channels to sell into? (Ex: Do we have an existing strategy for high net worth clients, but not for our small institutional clients? They may prefer investing in a mutual fund opposed to a private fund.)
  • Would offering a mutual fund provide operating efficiencies? Could consolidating many small accounts into one portfolio make it easier to manage?
  • Could a mutual fund provide a new revenue stream, helping to diversify revenue sources in an additional channel?

Investment Strategy Delivery Channels

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Calling in the Experts…

Ultimus IconBefore delving into all the details, which can be overwhelming, we want advisers to know that Ultimus is here to assist throughout the process. We have been in the mutual fund servicing business for nearly twenty years and can help make launching a mutual fund an easier process for investment advisers. We take a consultative and educational approach to fund launches and offer valuable advice based upon our years of experience of designing and launching funds.

Why is a Mutual Fund Also Called a ’40 Act Fund?

The more familiar term ‘mutual fund’ is a simpler name for the most common type of ’40 Act fund. All such funds operate under the Investment Company Act of 1940 and its associated rules, which were put in place to protect investors.

In a mutual fund structure, investment advisers purchase a portfolio of securities at their discretion while adhering to predetermined investment objectives. Mutual funds offer considerable portability, accessibility, transparency and diversification for investors, which allows for great opportunities to advisers when marketing the fund.

Who’s Governing?

Mutual fund investment portfolios are managed by separate entities known as investment advisers. Technically, the fund hires the investment adviser to manage its assets. Each investment adviser and mutual fund must be registered with the SEC, and therefore are subject to SEC regulation. Both the adviser and the fund are required to design and implement comprehensive compliance policies and procedures.

The Financial Industry Regulatory Authority (FINRA) also oversees marketing aspects of mutual funds.

In addition, the fund is required to have independent trustees, who are responsible for approving contracts on behalf of shareholders and have continual operational oversight of the fund. While such governance can require effort from all involved, it can also provide an attractive source of comfort for investors who appreciate the protections afforded by the structure.

Read more about how the mutual fund industry has evolved, written by Co-CEO, Founder and Managing Director, Bob Dorsey.

 

Lofty Goals: Designing a Long-Term Strategy and Key Factors for Mutual Fund Success

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So, “how much does it cost to launch a fund?” As with any new venture, it requires prudent forethought and planning to ensure the best chance of success. Advisers must consider both the initial upfront investment required to start the fund, as well as the potential ongoing financial commitment. Other considerations that should be taken into account are regulatory requirements, resource commitments and the timeline for launching the fund, just to name a few.

When considering launching a mutual fund, it is key to think about the long-term business plan for the fund. An adviser must have a long range perspective and consider not only the ongoing cost of launching a fund, but ultimately the cost of operating a successful mutual fund. Bob Dorsey, Co-CEO, Founder and Managing Director at Ultimus Fund Solutions

To learn more about achieving a successful mutual fund launch, read our blog post titled, “Launching a Mutual Fund: Cost of Success.”

 

Examining Fundamental Aspects Prior to Starting a Fund

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Which Fund Structure Works for You?

An adviser has two options to consider: series trusts or standalone trusts. A series trust is designed for investment managers who want to start their own mutual funds, but avoid the complexities associated with organizing a standalone trust. In the series trust model, the organizational structure, including its Board of Trustees, is already in place, reducing costs and saving time. The new fund becomes part of a trust with other funds, but each fund is its own separate entity and can maintain its own unique investment strategy and a distinct marketing image. Investment managers can focus on managing money and growing assets while the contracted service providers, such as Ultimus, perform the back-office services.

In comparison, a standalone trust is the preferred option for advisers who want to establish a family of funds and/or have greater involvement in the administrative duties of the fund. There is a more heightened control factor with standalone trusts than in series trusts. Investment managers play a key role in the selection of the initial board of trustees, fund officers, fund counsel, custodian, auditor and administrator. Like a series trust, organization fees are generally paid by the adviser, not the fund.

Both structures are viable options for advisers. One option is not better than the other; it’s simply the structure that best meets the firm’s long-term business goals. To learn more about mutual fund structures, click here.

Series Trust vs. Standalone Trust Structure

Key Differences Series Trust Standalone Trust
Control/Establishment Governed by an established/existing Board of Trustees and Officers, as well as, pre-selected Fund Counsel. Governed by a Board of Trustees selected by the Adviser. Requires new trust establishment and adviser selection of officers, fund counsel, etc.
Creation Timelines 4 to 5 months 6 to 7 months
Operational Costs Funds/Advisers share trust fees with other entities in the trust, taking advantage of scale and efficiencies of the shared structure. Funds/Advisers are solely responsible for the fees associated with the trust.
Start-up Costs Fees are normally paid by the adviser, not the fund. Likely a lower cost than standalone. Fees are normally paid by the adviser, not the fund.
Adviser Preference A cost effective and time efficient way for advisers looking to launch a mutual fund. Typically preferred by advisers looking to start a family of funds or wanting involvement in board selection/participation.

In addition, advisers must consider the different types of open-end and closed-end fund structures. View the options here.

Learn more about series trusts and standalone fund structures on these dedicated pages or...

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An Eye for Details – Diversification and Liquidity

Based on the 1940 Act and IRS rules, mutual funds must be invested in securities that are diversified and have a high degree of liquidity. Mutual fund regulations limit the ability to concentrate investments in an individual position; which means they don’t work well for strategies that require significant concentration.

Secondly, the mutual fund portfolio must be liquid to provide protection for the investor. Regulations require at least 85% of the fund’s investments be in liquid securities. This ensures that daily redemptions can be made, and offers an extra layer of security for shareholders. It is not uncommon for funds to outline a specific policy regarding investments in illiquid securities, which are sometimes more restrictive than the SEC requirements.

To learn more about the regulations and restrictions of a mutual fund, read our blog post titled, “Launching a Mutual Fund: Compliance & Regulatory Insights.”

Launch Sequence: Approximate Timeline

As mentioned previously, another difference between a series trust and standalone structure is the timeline to launch. While the graphic below is broken down by segmented time, there can be overlap amongst the processes.

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For more insight on the starting a mutual fund timeline, click here.

Advisers must go into the process with a strong understanding of each structure and ultimately make the decision that's best for their long-term mutual fund plans and business strategy. Dave Carson, VP, Director of Client Strategies at Ultimus Fund Solutions

Let’s Look at the Budget: Startup Costs and Fees

In both a series trust and standalone structure, there are one-time setup fees and ongoing operational fees. Series trusts are typically more cost-effective than a standalone trust due to trust fees being shared across multiple advisers/funds in the trust.

Organizational costs will range based on several factors (strategy, trust structure, service partners, etc.) Additionally, advisers need to consider the due diligence fees for platform access when budgeting for a fund creation. For more in-depth information, read our blog post Launching a Fund FAQs here or...

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One-Time Setup Fees

Fees paid to Service Provider (ex. Ultimus) Fund Creation and Trust Organizational Fee (if applicable) - Drafting, filing, etc.. Ultimus legal administration can take the lead in drafting registration statements and trust filings.
Outside Counsel Drafts and/or reviews filings for trust
Filing/Registration Various CUSIP and ticker charges
Standalone Trust Fees Seed Audit, Insurance, etc.
Platform Fees Platform Due Diligence Fees (will vary by intermediary)

Ongoing Operational Fees

Management Fees* The adviser recommends/proposes this fee (subject to board approval)
Operational fees Fees paid to service providers (administrator, auditor, legal, custody bank, etc..) as well as, state bluesky fees, SEC registration fees, trustee fees, and out of pocket fees (printing, postage, etc…), etc.
12b-1 fees If applicable – marketing and distribution fee allocated to the fund and included in expense ratio.

*Advisers generally set a management fee and enter into an Expense Limitation Agreement, establishing an expense cap for the fund. When the funds are operating above the expense cap, the adviser is required to waive a portion of their management fee to reduce total expenses to the capped amount. In some cases, particularly with a new, small fund, the adviser may need to reimburse the fund out of pocket to keep fund expenses below the cap.

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Learn about what it takes to break even in our insight article, “Breaking Down Breaking Even in Mutual Fund Operations – Why There is No Blanket Answer to the Break Even Question.”

Putting the Pieces Together: Organization Structure and Entities Involved

The graphic below demonstrates the various organizational components that service or are a party to a mutual fund. Hover over each segment for more information.

Ultimus range of Service Solutions - Clients have voted Ultimus’ quality of service #1 for 4 years in Global Custodian survey!
Board of Trustees - Oversees the management and operations of the fund and has fiduciary duty to shareholders
Investment Adviser - Serves as investment adviser to the fund’s portfolio
Counsel - Independent Trust or Fund Counsel provides legal representation for shareholders and / or trustees
Auditor - Provides an annual independent audit of the fund’s financial statements
Custodian - Bank or Financial institution responsible for holding securities owned within the fund
Administration - Supports Board governance process, regulatory filings, Prospectus updates and other related functions
Fund Accounting - Calculates the daily net asset value of the fund, manages expenses, and produces financial reports
Transfer Agent - Maintains records of shareholder transactions and balances
Distribution - Supports the process of selling mutual fund shares and acts as distributor
Compliance - Addresses regulatory compliance obligations and manages regulatory risk

 

BEGINNING THE JOURNEY: STEPS TO LAUNCH

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Engage, Engage, Engage…Service Providers

It’s important to leverage the experience and expertise of fund service providers early in the fund exploration process. Ultimus educates advisers on the process and assists with required service provider engagements including recommendations for counsel, auditor and others needed. Ultimately, when it comes to organizing and launching funds, we will take the lead, managing the entire fund organizational process, guiding advisers throughout.

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Planning for Success: Product Design

Ultimus takes an educational approach to product design, guiding investment advisers through the many considerations that come with choosing the right product, trust and platform. Ultimus takes time to learn your investment strategy, target market, and business goals before creating your registration statement. Some common factors that can affect the construction of your fund are listed below:

  • Portfolio design and construction
  • Fund expense objectives
  • Comparable fund analysis
  • Prior performance assessment
  • Strategic business plan/goals
  • Minimum investment requirements
  • Investment management fee analysis
  • Share class structure to support distribution strategy
  • Shareholder access options (web, telephone, broker/dealer)
  • Product structure
  • Asset class considerations (small cap vs. large cap)
  • Distribution potential/channels/challenges
  • Structure: does a mutual fund make sense?
  •  

Limiting the Unlimited: Advisory Fees

The advisory fee is the percentage/basis point fee allocated to the fund and paid to the investment adviser for serving in that role. The amount is recommended by the adviser and approved by the board on a contracted annual basis (first contract approval is for 2 years, with one-year renewals thereafter).

Generally, the fee should be within the range of fees of peer or substantially similar funds, a review and process Ultimus will guide the adviser through. The fee is assessed based on the net assets of the fund and subject to waiver based on the fund’s expense cap.

Leveraging History: Prior Fund Performance

Advisers may be able to employ prior fund performance when launching registered funds. However, a substantial degree of consistency in asset management team, investment strategy and investment securities are all required.

Additionally, the use of prior strategy performance will be limited to the prospectus unless a private fund is reorganized to launch the mutual fund. Both Ultimus and the trust counsel will help assess consistency, as well as provide additional requirements.

SOLD! Distribution and Classes

There is no set standard for mutual fund share classes, however most funds conform to the common share class characteristics utilized below. Most commonly, funds will launch with an Institutional share class, as that is widely used across various distribution channels. Rationalizing which share class(s) to launch is a crucial step in developing a distribution strategy. Loaded share classes (those with commissions) have fallen out of favor in recent years and assets in those classes have been dwindling.

For more in-depth counseling on fund share classes, please

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SHARE CLASS TYPES

Investor Use of Class
Share Class Load Comments RIA BD Institutional Retirement Retail
A Share Front Average front end load of 3.75% to 5.25%. 12b-1 of 25 bps. No Yes No No Yes
C Share Level Typically charge 1.00% up-front with a 1.00% trailing 12b-1. Deferred fee applies. No Yes No No Yes
Institutional (INST) No-Load Class will not have any 12b-1 fees and generally no shareholder servicing fees. Minimums are typically higher and will range from $100k - $250k. Yes Yes Yes Yes No
Investor (INV / ADV) No-Load Class will often have a 12b-1 fee (25 bps) and/or Shareholder Service Fee. Minimums are lower. Yes Yes Yes Yes Yes
Retirement (R-6) No-Load Similar to an INST share class but will not have any additional fees - 12b-1, Shareholder Service Fee, Admin Svc Fee, etc…. No No No Yes No

Getting Down to Business: SEC Registration

Ultimus knows the art of preparing registration statements. We create ones that are broad enough to be flexible down the road, but also narrow enough so potential investors know how the strategy is going to work. Once completed, we will file the registration statement with the SEC. Towards the end of the second month after filing, the SEC will normally contact Ultimus with questions and comments. After all questions are resolved, the SEC will inform us that the fund is effective.

With our experience, we can help identify, in advance, new structures and strategies that may raise concern from the SEC. We can also help advisers evaluate how important these factors are to business needs and how to present them in the registration statement.

 

Reaching Your Audience and Growing Assets

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Prior to launching a fund, investment advisers need to develop marketing and distribution strategies that take into consideration their entire business strategy. Mutual funds are a specific delivery channel for an investment strategy; in that way they can be an extension of what you already do. However, because sales and marketing for funds are likely different than what you do today, it is important to develop a complete long-term business plan for fund launch and operation. Here are a few areas to consider.

Storytelling Time: Marketing Strategy

A marketing strategy involves understanding how financial advisers/investors are going to learn about your mutual fund. Developing your plan should include telling your story, creating a pitchbook and designing an online presence. We have strategic business partner relationships in these areas and can point you in the right direction. You can learn more about these mutual fund marketing tactics in an Ultimus blog post, which is included in a three-part series on launching a mutual fund.

Expert panelists shared stories and advice regarding the environment of marketing for mutual funds in our fireside chat, “Real World Marketing: Real World Stories.” Plus, industry thought leader, Bill Hortz, Dean of the Institute for Innovation Development, shared his valuable insights to help advisers create and develop their unique story.

Plan of Attack: Distribution Strategy

In addition to a marketing plan, a distribution strategy is essential for growing assets. Making a mutual fund available through various distribution channels to reach groups of investors requires experienced forethought and planning.

Selecting a capable firm to assist with mutual fund distribution efforts can be important. With Ultimus’ consultative and educational approach in this area, we are able to guide advisers through this challenging process. One of our insight articles, Five Critical Questions to Help Identify the Ideal Distribution Partner, highlights how investment advisers can go beyond vendor sales speak to find supportive distribution partners.

In the mutual fund market, customization is king. Managers shouldn’t rely on an “off the shelf” program or “check box” approach. It’s imperative managers align their distribution efforts with strategic firm goals, and find a fund distribution partner who understands those goals. Kevin Guerette, VP, Director of Distribution Strategies

Determining and Setting up a Sales Structure

In today’s distribution dynamic, there are several key considerations a mutual fund manager must think about before building their sales structure. Structure options include:

  • Traditional wholesaling: model deployed by an outside sales force that spends the majority of its time on the road, meeting with prospects and clients on a regular basis.
  • Hybrid wholesaling: model allowing sales team to work from an office location for a portion of their time, but also traveling in a concentrated geographic area.
  • Internal wholesaling: model driven by a team typically housed on-site at the fund company.
  • Virtual wholesaling: model utilizing an electronic method of sales outreach, using a firm’s website as home base for all content.

The route an investment adviser takes in building a sales structure depends on which option best suits their firm and their business goals. For a deeper dive on this topic, we examine those particular structures in this Ultimus Insight article, Wholesale Changes - Key Considerations for Launching Funds and Building a Sales Structure in the New Distribution Dynamic.

Distribution Platform Preferences

Planning which platforms to engage and when is an important part of a fund’s distribution strategy. While it may seem ideal to be on as many platforms as possible, a targeted approach and long-term engagement plan, customized to the business goals, is most effective. With Ultimus’ consultative approach, we help you determine which intermediary platforms make sense based on your target audience, timing, platform cost structure and business plan. Having years of experience and connections to leverage, we will walk you through the options and provide seasoned input for your consideration.

We hope this information has been helpful and insightful. To discuss this topic further, we are happy to be a resource and will guide you through the entire process.

If you think that launching a mutual fund will be a beneficial endeavor for your business or investment strategy,

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