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High Fees on Active Accounts

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Jul 27, 2020 12:34 am

I am struggling with the following quandary:

Over the years I’ve developed a very active options based strategy that requires A LOT of my careful attention. For this reason, I’ve only deployed the strategy for customers in the qualified investor category, for which I charge performance fees only (25% of gains - nothing if not gains achieved). I’ve been through 2 state audits and had no problems with regulators over that issue.

Until now, I’ve turned down smaller clients in the $10k to $50k range, because I cannot afford to take the time to fulfill compliance requirements for this type of investment. For smaller clients for which I have done this in the past, I’ve only charged my wrap fees of 1.5%. But the amount of activity needed and the reporting and compliance issues involved have caused me to realize I am losing money on these activities with smaller clients.

A buddy of mine in the business suggested I start a hedge fund, put all clients into that fund and trade it as one single trade. That is one possibility, but complicated as hedge funds are limited in the type of clients they can attract, and may only have up to 35 non-qualified investor clients. So with a $10k minimum I would be limited to a fund of $350k. Perhaps if I went after more clients than that, I could simply launch another hedge fund: “big risk high reward strategy A” , “big risk high reward strategy B” , etc. Any thoughts on whether that is an approach I can take? My reading suggests that the hedge funds are subject to a lot fewer compliance restrictions. Can anyone confirm that?

An alternative approach I was considering was to leave my qualified investors with a performance fee - as I do now -but to charge my nonqualified clients who wish to participate a much higher fee, since I’m not allowed to charge non - qualified clients a performance fee. To make it worthwhile I would probably be charging 1 percent a month for clients who wish to be in this highly active approach. I would continue to offer my wrap fees of 1.5% for my more traditional investment approaches (buy and hold with periodic rebalancing and high sector diversification). But frankly, most of my smaller clients know about the results I’ve achieved for my qualified clients and would prefer to opt for that approach.

Normally, a 12% yearly fee would be completely outlandish. But not on an approach that by design hedges out big downside risks and has had 1/2 the drawdowns of traditional approaches with about 3 times the returns (( 18% drawdowns with returns in 40-60% range for the last three years). So even after my 12% annual deduction my clients would end up better off than in a traditional 60-40, diversified portfolio approach. Yet now I could afford to continue servicing smaller clients.

A friend who runs another RIA told me that that would not be allowed by regulators, since the rates are so high they’re considered a form of usury.

If that’s the case, I’m even considering unconventional approaches: farming out the clients and having them set up accounts that are not in my purview and under my control, then having them shadow my trades while charging a monthly fee ($100) . I’d be content with the monthly fee as I would not be faced with the large administrative burden of daily to weekly phone calls, monthly reports, KYC regulations, etc, etc.

I have a securities lawyer but frankly he’s not well versed in these non-traditional questions. I’d rather hear from someone who’s been there, done that. Once I get feedback, I’ll give a call to my state regulator and run it by them.

Appreciate your feedback.