In the competitive market for financial advice, advisory firms often seek to find ways to differentiate themselves from one another. For firms with high-net-worth clientele, one way to do this is to offer alternative investments, such as private equity, private debt, or hedge funds, which may offer clients the ability to invest in a more diverse range of assets. In many cases, advisors place clients into funds run by third-party managers, which allows the advisor to rely on the manager’s expertise in that particular investment area as well as their back-office resources to handle the administrative, legal, and regulatory hurdles of running a private investment fund. However, it’s also possible for advisors to launch and manage their own private funds, which can allow them to further tailor their investment strategy to their clients’ needs and to grow their business by attracting more high-net-worth clientele, while potentially cutting out some of the cost layers that clients face when using third-party alts distribution platforms.
At a high level, private funds work by pooling capital together from multiple investors, which can be deployed in a variety of ways – from traditional investments like public stocks and mutual funds to stock in private corporations, private debt lending, commodities, real estate, and even more exotic investments like art, wine, or collectibles. Additionally, private funds can employ leverage, short selling, derivative strategies, and other methods to further manage the portfolio’s risk and return characteristics. The end result is that private funds may offer investors more diversification by investing in a broader range of assets than what’s found in the public markets; on the other hand, they can be riskier and less liquid than other investments, which is why generally only accredited investors (i.e., generally those with over $200,000 of income or $1 million in net worth) are allowed to invest in private funds.
For advisors who launch private funds, it can be costly to navigate the legal and regulatory complexities involved in getting the fund off the ground. Attorneys are needed to draft the fund’s offering documents, and if the advisor wants to avoid the need to register the securities or the investment company with the SEC, the firm will need to implement policies and procedures to ensure the fund meets the exemptions for those requirements. In addition, most RIAs will likely want to engage the services of a third-party fund administrator to facilitate many of the documentation, tracking, and recordkeeping requirements. All of which can make a private fund expensive to launch, with the typical cost for launching a small fund ranging from $40,000 to $70,000 (costs that are typically borne by fund investors) – although given that many of these costs are upfront when launching the fund, costs to manage the fund on an ongoing basis can be substantially less, depending on the costs of the third-party administrator being used and the complexity of the strategy being employed. However, advisers may also realize the operational cost benefits of launching a private fund since they would not need to execute many individual trades for clients through separate accounts.
The key point is that although private funds might not be appropriate for all advisors – since they require having clients who qualify as accredited investors, and having enough of those clients who can benefit from investing in the fund to provide enough capital to run the private fund cost-effectively given the overhead expenses involved to start and run one – they can still be worth exploring for advisors seeking to differentiate themselves and expand their service offerings for high-net-worth clients. And while the complexity and upfront cost of launching a private fund may be high, doing so may ultimately be worth it for the ability to unlock new business growth and deliver more value for clients, at least for firms that want to further differentiate themselves on the basis of their (private) investment offerings to clients!
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