Hedge funds and other alternative investments like private equity funds and real estate projects can be an exclusive club. The price of admission often ranges from $250,000 to $1 million or more, blocking out all but the wealthiest investors. For some registered investment advisers, one way to gain access is to pool clients’ money through internally sponsored partnerships.
RIAs that use such pools to get around third-party managers’ minimums can run them at cost and pass the savings along to investing clients. However, some advisers question whether in-house funds are worth the effort and point to potential conflicts of interest.
Stephanie Lang, CIO of $4 billion Homrich Berg Wealth Management in Atlanta, says her firm created its first private pooled vehicle, a fund of hedge funds, in 1988. That entity still exists, and Homrich Berg has launched a new private alternatives fund of funds every two years.
The firm, which views these limited partnerships as access vehicles for clients, doesn’t collect any fund-level fees beyond the applicable charge on invested assets under management; its standard levy is 1 percent. Each partnership pays its own bills for costs like legal and accounting expenses. Early offerings from Homrich Berg were sector-specific, investing only in real estate or energy, for example, but the funds have become more opportunistic, with concurrent investments in those sectors and in others, like private equity. Most of the recent opportunistic funds have raised between $40 million and $50 million.
This level of activity requires three full-time staff members to handle the internal funds’ administration, Lang says. Tasks include coordinating capital calls and distributions, working with accountants for audits and tax return information and monitoring a steady flow of e-mails and documents.
An RIA considering an internal fund should realize that it’s a “huge time commitment” for research and administration, Lang warns, but it has paid off for Homrich Berg. The funds have attracted new clients, and the committed capital has been in line with projections. “When we look back at how these investments have done, they do add that private illiquidity premium that we’re seeking,” Lang says. “And on the hedge fund side, they have added a risk-adjusted return to portfolios.”
Other RIAs developed pools for clients but eventually decided to close them down. Meghan Pinchuk, co-president of $1.45 billion Morton Capital Management, says that Lon Morton, the Calabasas, California–based firm’s founder, CEO and co-CIO, started a fund of hedge funds for clients in the early 1990s, before that type of structure was widely available. The fund had numerous diverse holdings and was open-ended: Clients could add or withdraw capital at regular intervals.
After Pinchuk joined Morton Capital in 2006, she took over the fund’s administration. Its small size and multiple investments in an open-ended structure created an “inefficient accounting nightmare,” she says. Given the increasing availability of quality alternative-investment options for clients, the firm closed the fund and returned investors’ money in 2013 and 2014.
Mark Willoughby, Atlanta-based CIO at Modera Wealth Management, says his $1.7 billion firm also stopped offering internal partnerships. In the mid-1990s Modera helped a small number of clients to evaluate and participate in private equity deals. But the middleman role of overseeing multiple clients’ positions proved to be cumbersome and time-consuming, so in 2004 the firm created its own partnership to consolidate administration and gain purchasing power. The partnership had a hedge fund portfolio and a private equity portfolio.
It was a successful venture whose assets peaked at about $35 million just before the credit crisis, Willoughby says. The administrative chores became onerous, though; the firm closed the hedge fund portfolio two years ago, and the private equity portfolio is winding down.
Modera’s principals were also concerned about a perceived conflict of interest in offering a proprietary product to clients, even though the partnership wasn’t a profit center for the firm. “As a fee-only adviser, we believe it presents us with a fundamental conflict of interest in trying to sell a product that we manufacture ourselves,” Willoughby says.
Today Morton Capital has arrangements with hedge funds and other alternatives managers that allow its clients to invest at lower minimums. Pinchuk has blunt words for RIAs thinking about creating their own pools: “Don’t do it — that’s my best advice.”