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The increasing interest in alternative investments from registered investment adviser (RIA) clients in the U.S. is driving a corresponding increase in the number of pooled investment funds that RIAs are launching themselves in order to access alternative investment strategies such as private equity and real estate that might have minimum capital commitments that are too high for just one individual client.
Launching a private fund can seem like a natural progression for RIAs seeking to expand their offerings, grow assets under management, or pursue more sophisticated investment strategies. However, many RIAs enter this realm with misconceptions that can lead to operational, regulatory, and strategic challenges.
Launching a Fund is Similar to Managing Individual Portfolios
One of the most significant misconceptions is that running a private fund is just an extension of managing individual client portfolios, only on a larger scale. In reality, fund management introduces a level of complexity that many RIAs may not fully appreciate. While RIAs are used to tailoring portfolios for individual clients based on risk tolerance, goals, and time horizons, a fund requires a different approach. The RIA must manage the capital of multiple investors with potentially varying preferences, while maintaining a single, cohesive investment strategy for the fund as a whole. This often requires specialized knowledge in areas like portfolio construction, liquidity management, and allocation decisions that aren’t typically required when managing separate accounts.
I Can Use the Same Fee Structure I Use with Individual Clients
RIAs may assume that they can apply the same fee structures they use for individual clients to their private fund. However, private funds often require different, more complex fee arrangements. Many funds use performance-based fees, such as the “2 and 20” structure often quoted in the media when discussing hedge funds (although this is less accurate these days), which is quite different from the asset-based fees RIAs typically charge individual clients. Additionally, performance fees introduce legal and regulatory complexities, including restrictions under the Investment Advisers Act of 1940, which requires specific disclosures and provisions to ensure that fees are fair and transparent to investors.
Raising Capital for a Fund Will Be Easy
Another common misconception is that raising capital for a private fund is a straightforward process, especially if the RIA has a base of high-net-worth clients. However, marketing and raising capital for a fund is fundamentally different from onboarding individual clients. For one, funds often require larger capital commitments and lock-up periods that might not appeal to clients accustomed to having direct control over their investments. Additionally, competing for investors’ dollars in a private fund space means competing with well-established fund managers, private equity firms, and hedge funds that may have longer track records and deeper institutional relationships. RIAs may find that raising significant capital for a fund is more challenging than expected, even among their current clientele.
Regulatory Requirements Are Similar to My Current RIA Practice
Many RIAs underestimate the additional regulatory burden that comes with launching a private fund. While RIAs are already regulated under the Investment Advisers Act of 1940, operating a private fund introduces new layers of complexity. Private funds, depending on their size and structure, may need to comply with exemptions under Regulation D, file Form PF with the SEC, and adhere to additional reporting and compliance standards that don’t apply to separately managed accounts. The regulatory framework around private funds can also change depending on the investor base, as funds targeting institutional investors or pension funds have different compliance requirements. Misunderstanding or underestimating these requirements can lead to costly mistakes or delays.
Once the Fund is Launched, It’s Easy to Operate
Some RIAs believe that after the initial setup, operating a private fund is a hands-off endeavor. In reality, managing a fund can require significantly more operational oversight than managing individual portfolios. Funds often need dedicated legal, accounting, and operational infrastructure, especially as they grow in size and complexity. Issues such as investor communication, fund accounting, performance reporting, and liquidity management can quickly overwhelm an RIA that isn’t equipped with the proper resources. RIAs may also need to hire or contract with third-party service providers, such as administrators and auditors, which adds to the operational complexity and cost of running a fund.
Launching a private fund can be an exciting opportunity for RIAs, but it’s important to understand the nuances and challenges involved. Misconceptions about fund management, fee structures, capital raising, regulatory requirements, and operational demands can lead to significant pitfalls. RIAs considering this path should conduct thorough due diligence, consult legal and compliance experts, and ensure they have the proper infrastructure in place to succeed. Increasingly, RIAs are turning to middle and back-office platform providers that can help them navigate the intricacies of launching a pooled investment vehicle for their clients and managing it after launch.
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Gregory Poapst is a Managing Partner at Fundviews Capital. Connect with him on LinkedIn here.
Fundviews Capital is a full-service end-to-end Fund Management Platform. Our platform provides a complete end-to-end solution for asset managers or wealth managers to structure, launch, operate and grow their professional investment funds. You can launch a fund in a matter of weeks, not months, and with minimal capital outlay – not only reducing the risk of launching a fund but also maximizing your chance of success. Once launched, you will find that a dedicated team of professionals is just a phone call or email away at all times, handling all aspects of the back and middle office for your fund.