From our perspective

We are always working to stay informed about the latest trends and news in our industry.  As a consequence, we form opinions about best practices related to fund industry trends, fund administration, accounting, organization and a host of other topics.

Money Market Funds

What are money market funds, risks involved in investing in money market funds, and the tools used to stabilize them?

Want to learn more?

Click here for more from the Office of Investor Education and Advocacy.

Fund fees

A hot topic.

But, exactly what are they and how are they allocated?

If you’ve ever wondered about this, Emily Laermer offers a great explanation in her Ignites article.

Want to know which pooled asset investment is right for you?

Click here to learn more.

Smart-beta ETFs take on Index Funds

ETFs have certainly captured the investment world’s attention over the last several years. There is now an index for almost everything. Active ETFs are gaining in popularity, and will likely be a major growth area over the next 10 years. Smart-beta funds are a combination of the two – an index that is modified to overweight and underweight either positions or sectors or both, in an attempt to track the index while slightly outperforming on a net basis.

The attached article from Ignites, is a good summary of what is happening with smart-beta ETFs.

index-funds-most-vulnerable-to-being-usurped-by-smart-beta

 

Interval Funds

By Kip Meadows

You’ve got chocolate in my peanut butter!!!

The commercial from years ago, “you got chocolate in my peanut butter”, with the response, “you got peanut butter on my chocolate” has always stood out as an example of how two completely separate concepts, each perfectly good in their own right, can become better when combined.

Interval funds are a bit like that.

Background on types of funds, how interval funds came to be

Understanding how an interval fund works is best in context of how other types of funds are structured.

Open end mutual funds

Open end mutual funds have an operating history dating back to the 1940s. “Open end” means that the shares in the fund are offered continuously, on each business day the stock exchange is open, and can be redeemed by shareholders selling those shares back to the fund on each business day as well.

The advantage to having an open end fund is that there is no limitation on new shareholder investment coming into a fund. The disadvantage is really the same issue – there is no limit on when shareholders can redeem their shares. Investment advisors managing open end funds must plan for the possibility of redemptions on each business day, which may limit fully enacting the investment advisors investment policies and strategy. Most funds choose to keep a certain level of assets in cash to meet redemptions, which dilutes investment return in “up markets”.

Open end funds issue new shares and redeem existing shares at net asset value. Net asset value is the value of all of the assets held by the open end fund, plus accrued interest and dividends less any accrued liabilities (operating expenses accrued but not yet paid).

Closed end mutual funds

Closed end funds are basically the opposite of open end funds in structure. A closed end fund raises assets in an initial offering. After the fund is established and operational, shareholders wishing to redeem must sell their shares to another buyer, through an open market sale just like selling common stock on the stock exchanges. The fund itself does not provide any liquidity for investors. The open market system of bid by a potential purchaser of shares and ask by a potential seller of shares is negotiated.

The advantage to a closed end fund is the investment advisor to the fund knows what assets are in the fund, and there is not a dilutive necessity to maintain cash positions for the sole purpose of meeting redemptions.

There are two primary disadvantages to closed end funds. The fund can only grow in size with secondary (and third and fourth or more) offerings. Any investor that did not purchase shares on the initial offering must either purchase shares on the open market or wait for a secondary offering. Since investment managers are paid as a percentage of assets, if the initial offering is not as successfully as desired, the fund may linger for quite some time at a smaller than optimal level.

The second big disadvantage is that closed end funds are not priced at NAV (net asset value, calculated based on the securities held by the fund less accrued liabilities), but are priced at a bid ask market price set by a market maker on the exchange. In order to “hedge” the valuation, and take into account the transaction costs of purchasing closed end funds on an exchange, just like any equity, the market makers almost always offers or “asks” a price that is less than or equal to the most recent estimated NAV of the fund. Since the underlying investment activity of the closed end fund is not known by the market, the bid ask is therefore typically below the actual liquidated value of the closed end fund. As a result, the measurement of performance is always below the actual investment activity.

Due to these negatives, closed end funds typically are not the most popular option for starting a new fund.

Best of both worlds?

Back when commercials on television were more fact based (or claim based), there were a lot of products claiming “new and improved”. Whether they actually were, of course, was up for debate. In the case of an Interval Fund, the structure and attributes is clearly better for the right situation.

An Interval Fund is able to continually offer shares for purchase to new shareholders, but limits redemptions typically to monthly or quarterly. The advantages to this structure are:

  • Able to continuously offer new shares, so fund can grow
  • Fund is priced at NAV, so performance is accurate at all times, and shareholders know that their transactions will be at fair value, not a value set by a market maker (which can happen with a closed end fund or ETF)
  • Fund liquidations are limited to known periods, so investment manager has fewer issues with liquidity concerns in having to meet daily redemptions

There are also some disadvantages to Interval Funds. Some platforms do not hold interval funds, with the stated reason being that there is a liability for the platform to track redemption requests. If a client of a platform firm requests a redemption for effective the end of the month, and the platform somehow missed processing that request at the appropriate time, there is liability for a gain or loss to correct the trade at the next available trade period. Most platforms do not feel there is enough “upside” in holding interval funds to justify that risk of loss that the platform would be excepted to cover.

Summary

While there is no such thing as a perfect mousetrap, Interval Funds can be a “perfect compromise” when an investment style is best managed limiting the need for liquidity or frequent valuation of difficult to value securities, with the option to accommodate demand for new shareholders with open ability to purchase new shares.

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In Praise of Boring Places Where Nothing Ever Happens

By Pete Hartman

(September 16, 2016)

At Nottingham we are sometimes painfully aware of the bias against out-of-the-way places. The common presumption in investing is that the best new ideas come out of the money centers. Our headquarters in Rocky Mount, NC has been dismissed as a backwater from time to time. However, we believe small places are the incubator for change. We believe that some of the very best revolutionary ideas come from overlooked corners, where experimentation is freely pursued without the smothering blanket of conformity.

And there is no better example that comes to mind than a little community down I-95 South of us called Dunn, NC. Ever heard of it? Probably not. But a native son of Dunn influenced an entire generation of music, and is credited with being the inspiration for a genre that is as distinctive as it is unsettling.

Fred Lincoln Wray, Jr. was born in Dunn, NC in 1929 and he imagined the sound of an electric guitar in a different way than others in the ‘50s. Because a bout with tuberculosis made singing difficult, he concentrated on developing a new sound as electronics and amplification were being introduced for guitars. His first big hit, “Rumble” in 1958, featured all the characteristics present in modern guitar playing: the powerchord, distortion, and deliberate feedback.

https://www.youtube.com/watch?v=BuAD_sQUgpw

“Rumble” was so incendiary and evoked such strong emotion in young listeners, the song was initially banned from radio in New York and Boston for fear it would cause teenage gangs to riot. As Iggy Pop once recalled, “I was at the Student Union…I heard this music…I left school emotionally at that moment, the moment I heard Rumble.” Link Wray quickly became the hero of juvenile delinquents and hooligans.

His song “Raunchy” was required learning of all budding guitar players.

https://www.youtube.com/watch?v=PKjEt8G5uj8

When John Lennon and Paul McCartney auditioned lead guitar players for a new group they had in mind, a young George Harrison selected this Link Wray instrumental as a sample of what he knew. They hired him immediately, and formed what we know as The Beatles.

Neil Young, Jimmy Page, and Pete Townsend all cite Link Wray as the source of their early rebellious inspiration. And thrash and punk rock musicians credit him as their godfather and pioneer of their raw musical forms.

Not bad for a guy- falsely thought- from a boring place where nothing ever happens.

How about you? Do you have a new idea, something really different that is looking for a forum to be heard or at least a sympathetic audience? At Nottingham, we believe in the power of ideas and action. So if you have an investment idea in mind, or haven’t gotten the benefit of a fair hearing anywhere else, we want to hear from you. Call us. If it’s new and really different, we’re all ears. And we won’t be biased if you are from a small place.

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Point / Counterpoint: Passive Investing

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(September 6, 2016)

Much has been said about the impact of passive investing.  Each of the following articles address a side of this issue.  Please read and share your thoughts!

checkmarkprohibition symbol - circle with line

What does a fund administrator do?

By  Kip Meadows
(June 14, 2016)

This question comes up periodically, and like the answer to many questions the short answer is “it depends”. From the Nottingham perspective fund administration falls into four functions and responsibilities:

  • Fund accounting
  • Transfer agency / participant recordkeeping
  • Compliance administration and oversight
  • Fund operations, cash management, receipts and disbursements, audit

Some funds use multiple vendors for the above functions, in which case the term fund administrator would certainly be narrower. In most such scenarios, the likely outsourcing would be fund accounting or transfer agency / participant recordkeeping or both. The fund administrator in either of those cases would most likely be viewed as the firm that oversaw overall operations, worked with the fund accountant and or transfer agent to compile year end records. On a day to day, month to month basis the fund administrator would be responsible for some or all of the following:

  • Fund documents
  • Coordination with outside legal counsel
  • Coordination with outside audit firm
  • Oversight of anti-money laundering (AML) and know your customer (KYC) reviews
  • Receive and retain shareholder subscription documentation
  • Payment of fund expenses
  • Coordination of board meetings and documentation

Sometimes it is just as important to understand what a fund administrator does NOT do, to avoid misperception, or an “I thought that was part of the service” misunderstanding what can leave vital functions unattended if faulty assumptions are allowed to linger.

Fund administrators are NOT:

  • legal counsel to the fund – Nottingham has an in-house legal team, as do many administrators, but at Nottingham we stop short of providing legal opinion on fund issues, primarily due to the potential for conflict since Nottingham is also a vendor to the funds we administer. This is a universal issue;
  • responsible for investment decisions or transactions – While administrators will typically assist with the monitoring of portfolio investment policies and restrictions, the ultimate responsibility always resides with the investment advisor, not the administrator;
  • Financially responsible for fund obligations – Funds are their own entity, and the assets and liabilities of funds are fund assets and obligations to satisfy, not liabilities and obligations of the administrator.

So the short answer to “what does a fund administrator do?” is “it depends”, but the longer answer is that a qualified fund administrator either performs internally, or has relationships to assist the fund, in carrying out all of the day to day operations exclusive of portfolio management. It is a good fund administrators’ goal to allow investment management professionals to focus on their core competency, managing assets, and handling all of the fund details to allow that to happen.

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The ABC's...and I's...of Mutual Fund Share Classes

By Ashley Harris 
(May 20,2016)

Mutual Fund share classes may differ by their internal expenses, potential front-end or back-end sales loads, investment minimums, and availability to different types of investors.  The primary difference between each share class is the fees and expenses associated with each class of shares. Each class represents a similar interest in the portfolio.  Investment companies with more than one class of common stock usually identify a specific class with an alphabetic indicator, such as “Class A Shares” or “Class C Shares.”  The differences between each class affects investment returns over time.

Class A Shares

Class A shares typically charge a front-end sales load at the time of purchase.  This means that a specific percentage of your initial investment is taken out as a commission, so a portion of your dollars is not invested.

Pros to investing in Class A shares:

  • Class A shares are subject to lower 12b-1 fees than Class C shares, so the shareholders usually pay lower expenses and receive higher dividends. As a result, Class A shareholders usually see higher returns than Class C and Class B shares, but lower returns than Institutional Class shareholders.
  • These shares may also provide a discount off regular front-end sales load rates each time your investment reaches a certain breakpoint.
  • You may not pay an initial sales load if Class A shares are purchased by reinvesting dividends and distributions or if the Class A shares are exchanged for another series in the same family of funds.

Cons to investing in Class A shares. If investors do not have the funds to reach a breakpoint before a specified deadline, they may have to pay the regular front-end sales load.  Investment is also not advantageous if investors have a short time horizon.  You may actually lose money by liquidating early.

Class B Shares

Class B shares are a classification of common stock that typically carry contingent deferred sales loads (CDSL), or back-end sales loads.  This share class may also impose asset-based sales charges that are higher than those for Class A shares.  Investors do not pay anything upfront, but rather a charge when shares are sold, depending on how long you hold them.

The expense ratios for Class B shares are typically much higher than other share classes.  There are also no breakpoints on the contingent deferred sales charge, so there is no discount offered on these charges.

Pros to investing in Class B shares:

  • There is no front-end sales load, so your entire investment earns interest income.  The longer you hold your shares, the lower the contingent deferred sales charge.
  • Class B shares automatically convert to Class A shares after a certain period of time, which is beneficial because Class A shares have a lower annual expense ratio.
  • Class B shareholders typically see lower returns than Class A and Institutional Class shareholders due to the CDSL.

Class C Shares (also referred to as Retail Class Shares)

Class C shares are a classification of common stock that have a level load.  They do not have front-end sales loads, but these shares have small back-end sales loads.

Class C shares typically have higher annual expense ratios than Class A shares but lower expense ratios than Class B shares.  Therefore, shareholders usually pay higher annual expenses and receive lower dividends than Class A shareholders.  There is no conversion of shares like with the Class B shares, so they cannot be converted into Class A shares for the opportunity to lower the annual expense ratios.  The investment returns may also be reduced the longer you stay invested because the fees add up over time.  There are usually no breakpoints offered on the Class C shares.

Pros to investing in Class C shares:

  • These can be a good option for investors who want to sell their shares after a short period of time but will hold the shares for at least one year.
  • There are no front-end sales loads, so the entire initial investment can earn interest income and, possibly, result in higher returns.
  • The back-end sales load is typically only 1% for the first year the shares are held.  After the first year, the back-end sales load is usually removed.
  • Class C shareholders usually see lower returns than Class A and Institutional Class shareholders due to the back-end sales load and shorter time duration of shares held.

Institutional Class Shares (also referred to as Class I)

Institutional Class shares are available for sale to investing institutions, usually on a no-load basis.  These typically have sizable minimum investments, so any front-end sales loads are generally waived on these shares. Institutions may buy a significant number of shares in this class at any one time, so they can receive breaks on commission charges.  This share class does not include a 12b-1 fee.  The Institutional Class shares may be offered for direct investment by investors as part of a pension or profit sharing plan, employee benefit trust, endowments, foundations, and corporations.

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It's open. It's closed. No, it's an interval fund!

By Kellie Masters
(June 30, 2016)

Since the Investment Company Act of 1940, investment companies could generally be described as either open-end or closed-end. Open-end companies issue redeemable securities, meaning that the investor can sell shares at any time back to the investment company, who must pay the investor’s redemption within seven days.  Open-end funds have to maintain a certain level of cash and liquid assets, limiting the fund’s investment options.  Closed-end funds do not issue redeemable shares.  With no restrictions on the amount of cash to maintain, they can pursue a less-liquid investment strategy, choosing investments that are higher on the risk/reward scale.

So, wouldn’t it be nice to have the best of both worlds? In 1993, Rule 23c-3 was adopted, which essentially paved the way for the introduction of interval funds.  An interval fund allows for purchases at any time, like an open-end fund, but allows the fund to offer periodic repurchases (generally every three, six or twelve months) during which the shareholder can redeem some or all of their shares.  The advantages are obvious: a limited level of liquidity for the investor and the ability for the portfolio manager to choose from a broader array of traditional and alternative investments.

Although interval funds are becoming more popular, there are not very many investment administrators that are willing and able to support them.  Nottingham is a “boutique” administrator that specializes in creating solutions for innovative investment products, including interval funds.

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Related Performance and Mutual Funds: Advertising Your Strategy's Pre-Fund Performance

By Matthew J. Beck

(May 5, 2016)

Here at Nottingham, many of our clients are experienced money managers with successful proprietary strategies. Their SMAs are flourishing; perhaps they manage a private fund; or maybe they even sub-advise a sleeve in a mutual fund – and now they want to expand on that winning formula with their own dedicated mutual fund.

From the clients’ perspective, the legal and regulatory structure of their mutual fund is just a different cloth draped around the same underlying form. Whether it’s an SMA, a private fund, a sub-advised sleeve, or their new mutual fund, at the core it’s still their strategy. Thinking about it that way, it seems only obvious that a new Fund’s advertising would focus on the historical performance of the strategy. This data, the performance of products sharing the same strategy as the Fund, is what is referred to as “related performance.”

One would think that it’s perfectly normal and reasonable to provide prospective investors with this related performance. In fact, to a great extent, the SEC agrees. As outlined in various no-action letters, the SEC has long permitted a mutual fund’s prospectus to include related performance. As long as certain conditions are met, you’re free to show – in the prospectus – how your strategy has historically performed in order to give investors an idea of how the mutual fund might perform.

However, the next bit is where our clients often find themselves frustrated. What you’re allowed to show in the prospectus and what you’re allowed to advertise outside of the prospectus are two entirely different things. The SEC controls what is permissible in a mutual fund’s prospectus, but the SEC delegates some of its authority to FINRA when it comes to broader advertisements, and, until very recently, FINRA had taken the stance that related performance was completely prohibited.

If that dichotomy sounds like an absurd regulatory contradiction, you’re not alone in that thought. Due to these divergent interpretations, you were allowed to publish related performance in the most important public document related to the Fund – its prospectus – but you weren’t allowed to copy that same performance data in marketing material. Nor were you allowed to communicate in such a way as to reference or direct prospective investors to the specific part of the prospectus containing the related performance.

The confusing nature of this did not escape FINRA, and to their credit they did at one point submit proposed amendments to the SEC in order to bring their two rules in line with one another. The SEC chose not to act on those rules, and they were eventually withdrawn in 2004.

However, all was not lost. In May, 2015, FINRA issued a new interpretive letter. This time, FINRA finally allowed mutual funds to advertise using related performance in certain circumstances. The most important of these circumstances is that the marketing materials must be for institutional parties only. As defined by FINRA Rule 2210(a)(4), this encompasses a variety of persons both natural and corporate, but generally it refers to registered investment advisers, government entities, banks, and/or entities with over $50 million in assets. Unfortunately, as of the publication of this article, FINRA still prohibits the use of related performance in fund advertisements aimed at the general public or retail investors.

Beyond restricting this type of marketing to institutional recipients, there are also a number of other strings attached to its use. There are more beyond this summary, but the most significant requirements are these:

  1. First, the presentation must include performance for all related accounts – meaning that a portfolio manager cannot pick and choose which of their related accounts to include as related performance. Every portfolio that shares substantially the same strategy must be included;
  2. Second, the related performance must be presented net of fees and expenses of each specific account (as must the data for the mutual fund itself);
  3. Third, the related performance must be for a period of at least one year and be current to the most recent calendar quarter end;
  4. Lastly, any material differences between the mutual fund and the related accounts must be disclosed and explained.

To summarize, if you are a portfolio manager with a strategy being duplicated from your other products, you may be allowed to do the following when it comes to your mutual fund:

  • Include the performance of those products in the prospectus of the mutual fund; and/or
  • Include the performance of all of those products in advertisements sent only to institutional parties.

However, under the current regulatory framework, what you still cannot do is:

  • Publish related performance in advertisements to retail parties (i.e. the general public); or
  • Republish the related performance from your prospectus in peripheral advertisements to retail parties; or
  • Reference or direct retail parties directly to the section of the prospectus which contains that related performance.

As always, advertising compliance can be a subjective affair, and there are an endless number of restrictions and considerations beyond those contained in this brief snapshot. Whether you are a current Nottingham client, or a prospective advisor with a successful strategy that you want to leverage, please feel free to reach out for a consultation. Regulatory compliance is a maze, but we’ll help you through it every step of the way.

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Top Ten Ways Your Portfolio could benefit from unitized accounting

By Kip Meadows
(April 21, 2016)

10. Ability to combine many smaller accounts together for consolidated
investment management

9. Most accurate way to allow inter-period participant entry and exit
to portfolio

8. Superior to master trust accounting as percentages are used, which make
intra-period transactions difficult or inaccurate

7. Superior to master custody accounting, where trades are still held in each
subaccount

6. With multiple portfolios by investment style, ability to provide broad asset
allocation to participants regardless of dollar amount

5. Allocation of cost to administer on a pro rata basis among participants
through unit value (NAV) calculation process

4. Most stringent GAAP accounting standards, using 40 Act mutual fund
methodology

3. Reporting that accurately breaks down performance

2. Even though investment management consolidated, participants still receive
the most accurate record of cost basis, realized and unrealized gains, and
investment income

1. Tastes great, less filling!

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Have a Question? Ready to Get Started?

Do you question the status quo?  Like to think outside the box?  Have difficulty coloring inside the lines?

We’re kindred spirits. Our practical experience – along with formal training in diverse areas like accounting, technology, finance and the law – provides you with a deep resource for creative thought, design and engineering. Tell us what you have in mind and we’ll explore together the possibilities.

Contact Us

About Nottingham

Nottingham has been serving the fund accounting, administration, organization, and management needs of clients nationwide for nearly three decades. Based in Eastern North Carolina, Nottingham delivers a full range of turnkey services, handling clients’ behind-the-scenes financial and administrative operations so they can focus on managing their portfolios.

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Get In Touch

  • 116 South Franklin Street
    Rocky Mount, NC 27804
  • Phone: 252. 972.9922
  • Fax: 252.442.4226