Deep Pockets Needed to Start Your Own Fund

You’ve earned a reputation as an astute stock or bond picker, and your friends now want you to manage their money. Is it time to start your own mutual fund?

Probably not.

Mutual funds are more popular than ever, but the field has become so crowded that new money managers often have a difficult time attracting much of a following. Because of the intense competition and significant start-up cash needs, the odds are stacked against newcomers hoping to make a big splash.

“It’s a very regulated business, with tons of things to watch out for,” says Edie Sutker, an officer of Chicago-based Oakmark Fund, a top-performing portfolio that bucked the trend by attracting $625 million in just a year and a half.

“Just picking a name can be a drawn-out process,” she says. “The details are amazing.”

So are the costs. Anyone wanting to start a mutual fund needs to invest at least $100,000 in portfolio “seed money,” which can’t be withdrawn for at least five years, says Burton J. Greenwald, a Philadelphia management consultant specializing in the fund industry.

Then things start to get really expensive.

Because the fund business is so closely regulated, the start-up legal fees alone might run $25,000 to $100,000 to have a law firm prepare a prospectus acceptable to the Securities and Exchange Commission, says Richard J. Capalbo, a partner at Ascher Decision Services, a fund distribution firm in Los Angeles.

That’s in addition to $25,000 or more to print a final prospectus for investors, and perhaps another $25,000 to print a statement of additional information, also known as Part B of the prospectus, Capalbo says.

So much for federal regulations. You would also need to spend about $1,000 or so a year to register in each state in which you plan to sell shares. “Figure on $50,000-plus a year in all 50 states,” says Arthur Loring, vice president and general counsel at Fidelity Research & Management, the investment advisory arm of the Boston-based fund giant.

Registration and other start-up expenses will vary depending on the caliber of legal and other services you require, the number of shares you sell and other factors.

“But it wouldn’t be unreasonable to think you might spend a quarter of a million dollars” in combined start-up costs, says A. Michael Lipper of Lipper Analytical Services, a fund monitoring and consulting service headquartered in Summit, N.J.

And plan on tens of thousands of dollars more for each year you’re in operation. Capalbo estimates that accounting fees might run $25,000 to $50,000 a year per fund, plus another $15,000 to $20,000 for administration, $50,000 to $100,000 in transfer-agent and custodian help (two separate services that are often packaged together) and $5,000 for ongoing legal review.

This last expense is needed to “make sure the portfolio manager doesn’t violate any terms of the prospectus,” Capalbo says.

Most fund sponsors are already in the investment advisory business, so there might not be much in the way of additional portfolio management expenses. But you would need to hire at least three outside directors to oversee the fund’s operations. The pay here might range from a few thousand dollars to $25,000 or more per director each year, plus travel expenses.

Many expenses can, of course, be passed on to shareholders. But until a portfolio grows large enough to absorb the various costs, the sponsoring firm might have to eat some of them. That’s because regulators in certain states won’t allow funds to charge shareholders more than 2.5% in yearly operating expenses, Greenwald says.

Now comes what might be the most costly part of the equation: marketing.

“Unless there’s a viable way to distribute a fund, it’s almost doomed to failure,” says Greenwald. No-load funds rely on advertising and media exposure to attract investors. Capalbo considers a $100,000-a-year ad budget realistic, plus perhaps $35,000 annually to retain a public relations firm to help get the word out to the press. The eight or so largest no-load families each spend $5 million a year or more on advertising, Greenwald estimates.

Selling through a commission channel--brokers, financial planners, insurance agents and banks--can be even more costly. Figure on $250,000 to $300,000 to push funds through the load distribution network, Capalbo says.

Expenses here include hiring wholesalers to visit local brokerage offices and printing special marketing literature for broker use.

Load funds that sell different “classes” of shares often require additional legal help, to the tune of perhaps $25,000 to $50,000 in prospectus work, Capalbo says. This is needed to prove to the SEC that the fund will equitably split costs among the various share classes.

Then there’s the time factor of getting your fund approved. Time, after all, is money, because the longer you have lawyers working on a project, the higher your bills will be. Also, lengthy introductions could result in lost sales if competitors beat you to the punch.

If a portfolio is merely tacked on to an existing trust to become one in a series of related funds, approval might come in as little as two months, Loring says. Otherwise it takes longer, especially if the fund company is new or the investment or marketing approach unusual.

“If the documents are in proper order, you might get it done in four months,” Lipper says. “But as a practical matter, from the time you get an idea to the time your fund is up and running, figure on about a year.”

Although the fund start-up process might seem like an onerous mix of cost, time and red tape, there is a silver lining: The various regulations protect investors and have generally kept the industry scandal-free.

Getting the Ball Rolling Starting a mutual fund requires more than a knack for picking investments. You would need at least $100,000 in “seed money” to germinate the portfolio. Plus, you would have to contract out for essential services you couldn’t handle yourself. These services might total $100,000 to $250,000 or more during the first year of operation. Key parties would include: Attorneys, needed to prepare a prospectus, including the statement of additional information. Attorneys also monitor the fund’s activities to make sure they don’t violate securities laws. Accountants, who audit the fund’s financial documents and help prepare periodic reports to shareholders. The transfer agent, who maintains shareholder-account records and handles transaction orders. Printers, who print the prospectus and financial reports. The custodian, typically a bank, which stores and safeguards the fund’s cash and investment holdings. The administration company, which supervises the various other parties on a daily basis and advises the directors. The management company, often the administration firm, which makes investment decisions and trades securities for the fund. The distributor, which markets and promotes the fund. Distribution activities include advertising, public relations and marketing to brokers. Directors, who, as the shareholders’ representatives, oversee the fund’s policies and vote on key issues, including whether the portfolio manager should be retained.