The Truth About Track Record Portability

Jul 24 2014 | 5:55am ET

Myths, Misperceptions and Considerations for Leveraging a Private Fund Track Record in the Retail Space

By Dave Carson
Director, Ultimus Fund Solutions

The number of private funds converting to mutual funds has increased significantly in recent years. The rise of liquid alternatives has created a steady stream of conversions as hedge fund managers look to take advantage of the growing demand for alts strategies in the retail space. And coming off the market crash of 2008, many private fund managers have several years of positive returns, making the move to a mutual fund a much more viable option.

There’s no denying that the potential pool of assets in the retail space is enormous, but the size of the opportunity for managers is directly proportional to their ability to standout in an increasingly crowded market to an increasingly skeptical investor base.

In the absence of other tangible measures, many investors view past performance as the best indicator of future success when it comes to fund managers. In fact, in some cases a track record is the primary factor investors use during the process of choosing which funds to invest in or not. So when a manager is converting a private fund to a mutual fund, the ability to leverage the track record from their previous fund becomes a critical marketing asset.

What’s important to remember is that while managers may have different strategies, the requirements and processes for achieving track record portability are largely the same for any private fund conversion. Unfortunately, there is a lot of confusion among managers about whether their private fund track record can be portable, what steps they must take to make it happen or even how they can use the track record if it is portable.

The process for converting a private fund to a mutual fund can be onerous and tricky in general and the steps to achieving track record portability add another level of complexity. It’s important that managers work with competent and experienced counsel to help guide them through the process in the most efficient and effective way.

To help managers considering a conversion, below are few helpful hints that should dispel some common myths while making the path to track record portability much more clear. 

The Private Fund vs.  Separate Account Dilemma -- There is a perception among some fund managers that a private fund track record will not be portable in a retail structure under any circumstance. That perception is inaccurate and likely stems from confusion between private funds and separate accounts. While it is true that a track record from a separate account strategy is not portable, that is not the case with private funds as a whole. If a private fund manager follows the right steps and meets the proper criteria, a track record can carry over into a mutual fund. On a side note, a manager can absolutely convert separate accounts into a mutual fund but the track record would not be portable.

The Morningstar Misperception – While a portable track record is a marketing asset that a fund can begin using as soon as the necessary regulatory filings are complete, managers must understand that track record portability does not mean Morningstar-rated.  The fact is Morningstar will not rate a fund until after the third anniversary of the fund’s launch. A fund with a portable track record will be listed by data reporting services like Lipper and Bloomberg, making the fund more visible to institutional investors. So there are clear marketing benefits of carrying over a track record but an immediate Morningstar rating is not one of them.

Performance Accuracy is Paramount – When it comes to performance, the numbers cannot be open to interpretation. Advisors must validate their performance calculation and ensure the accuracy of the numbers they represent. The SEC will respond 30-45 days after the original prospectus filing to ask if the manager is willing to represent the numbers. If so they will be entered into the fund’s books and records. The SEC will check and double-check those numbers and if there is a discrepancy they will find it.  The advisor must know their numbers are right and have a rationale to support them if they want the support of the SEC to achieve track record portability.

Portability Requires Continuity -- For track record portability to be achieved the SEC requires continuity of a fund’s staff and strategy from a converting fund that is a single legal entity.  Specifically the SEC requires that the investment strategy be, “substantially identical” and that the advisory and portfolio management staff must be consistent. If the case can’t be made for both, the case can’t be made for portability.

A Private Fund Can’t Be a Stepping Stone – According to regulations, a manager can’t have a stated plan of action to create a private fund as a step toward a mutual fund with a portable track record.  For that reason, private funds looking to convert after only a short time in existence are likely to raise questions with the SEC. Beyond the a fund’s lifespan, the SEC looks more favorably on funds with multiple year track records that have been audited by an outside firm.  To put it simply, the longer the track record and the stronger the audit trail the more likely portability will be achieved.

Closing Thoughts

There are a slew of other considerations managers need to contend with in the conversion process; from choosing a stand-alone or a series trust, to ensuring the structure is set up effectively from a tax standpoint, to working through all the details of the registration filing. Each one of these components can potentially be e a barrier to track record portability, which is an excellent reason to seek expert advice in advance. 

It’s unreasonable to expect managers to be experts in all of those critical elements. But by being armed with these practical pieces of knowledge and working with true experts, pitfalls and barriers can be identified and dealt with realistically. Hopefully the points above provide managers with more information about the process and clears up all too common misperceptions. As more and more conversions are taking place, a portable track record can be a very useful tool for long term success. That’s not a myth.

Dave Carson is director of client strategies for Ultimus Fund Solutions. Dave has been in the financial services industry since 1981, and has almost twenty years of fund and asset management experience. Dave has been chief compliance officer for mutual fund families, registered investment advisors, and an ETF trust. He also served as chief operations officer for a mutual fund family, and previously had senior management responsibility for fund and advisor marketing, fund wholesaling, transfer agency, shareholder servicing and advisor compliance.

Dave is co-founder and president of Advancing Fund Governance, a forum for fund trustees and senior officers. He is also a former trustee and secretary of the Greater Cincinnati Mutual Funds Association.


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