Spoke Fund ®

Cale Smith

Here are three things I wished I’d done differently when first setting up my Spoke Fund and my firm. This is certainly not an all-inclusive list, but these in particular have come up recently in conversations with prospective Spoke Fund managers.

1. Having a good CRM (customer relationship management) tool on day one.

At the end of 2008, I got an email out of the blue from a reasonably well-known fund manager whom I admired. He’d somehow seen the positive plug I gave his mutual fund company in this slideshow and was basically checking in to say, “thanks and good luck.” I thought it was extremely cool.

It also led to a ten minute phone conversation, during which he asked about the Spoke Fund model, my philosophy, and referred me to someone else he thought I should talk to. Near the end of the call, perhaps sensing he had driven most of the conversation, he wondered if there was anything I wanted to ask him. So I asked, “What’s the single most important piece of advice you’d give to someone just starting a fund?”

I was hoping his answer would make time stop and the seas part – you know, that he would bestow upon me the sort of unfathomable wisdom only available to a salty veteran who managed billions of dollars of other people’s money.

Instead he said this:

“Get yourself the best CRM tool you can find, because you’re going to need it.”

After scratching my head for a bit, I went out, swallowed hard, and spent $1200 on Salesforce.com…and then proceeded to bang my head against the wall for two weeks trying to figure out how to tame it. After that, I quit out of pure frustration, and really soured on all CRM tools in general, for about a year. Nothing I couldn’t do myself a lot cheaper with a spreadsheet and Post-it notes, I figured. Never mind what that grizzled old-timer had told me.

And the truth is that I really didn’t need a CRM tool that first year to help land my early investors. They were going to invest, regardless. But that circle only gets you so far, and I blew some chances early on to expand my early investor base outside that friends-and-family group because I had too much going on and no good way to track leads. Now, in year three, and having just spent a sporadic three months working on and off with my VA to finally get my CRM program updated and really making it an asset, I am kicking myself for not having that tool up and running earlier. Like, much earlier…meaning on day one, just like the man had said.

I have blown a not-insignificant amount of business by not being better organized about responding to leads and prospects, period. And that wasn’t really obvious until I’d looked back. If I’d had a really good, up-to-date tool, my business would be further along.

So, entering that stuff initially into a CRM system can be a bit tedious, and it will seem a bit unnecessary at first, but if I did it over again, that would be the first thing I’d do differently. Start on day one – not necessarily because it will bring investors in the door right away, but because it’s important to have a system that you have full confidence in when it comes to maximizing the opportunities to have real conversations with people who could become investors.

Finding new investors can be a real grind, and at various times I think the process makes everyone at some point flop dejectedly onto a couch and ask themselves, “What can I be doing differently here?” And while I’m not sure I know the exact answer in every case, I do think that in many cases that answer probably starts with, “Get a real process.” And that means CRM.

And as I’ve mentioned before, now I use Highrise by 37signals as my CRM system. Much better, simpler and cheaper than Salesforce. Probably worth more of a discussion down the road.

2. Combine my blog and my website.

This is a more recent revelation. As background, I have two sites for my business…the main company site at www.islainvest.com and my blog which is hosted at its own domain at www.caleinthekeys.com.

The reason I have two sites is that, basically, I wanted to stay local in picking the firm that designed my website. Alas, at that time (three years ago), they couldn’t quite figure out how to easily integrate the look of a blog with the rest of the site that I wanted. So I just went out and did the blog independent of my firm’s site. And in what may be a prime example of confirmation bias, that separation has made sense to me over the years – because it enabled me to do some things on the blog I probably wouldn’t do on the website. Like bragging about bonefish, for instance.

Turns out, though, that I get a lot more traffic to my blog than I do my main website. For a handful of reasons, my Google juice is higher for the blog. And as I’ve started talking to some SEO guys about a handful of online marketing things I’m considering, they have each in so many ways said the same thing:

My main website would be showing up a lot higher in Google searches if my blog was hosted at www.islainvest.com, instead of being a separate domain. Significantly higher.

There is a lot more to search engine optimization, keywords, backlinks, etc. than I will probably ever know, but this particular combo seems like a no-brainer given that had I done it earlier, (1) I’d have been saving money on hosting just one website instead of two and (2) it would have produced much better results in Google – which would likely have lead to more investors.

So, save money, more investors. Gotta consider that, no?

It’s hard to guesstimate how much of that additional re-directed traffic would have actually resulted in new investors over the years, but I’m pretty sure it would have resulted in more sign-ups for my email list, and as I’ve mentioned before, that has really been my top sales tool. And now, to combine the two, it’s going to cost some bucks.

So, again, with the benefit of hindsight, I’d have done that differently. Plus WordPress templates are pretty amazing these days, so it’s all easy enough to do cheaply right out of the gate.

3. Monthly, not quarterly, billing.

I made this change after my first year, and am thankful for it. I originally launched my Spoke Fund under a quarterly billing plan, meaning FOLIO deducted my fees from client accounts and forwarded them to me four times a year. At the time, a quarterly plan seemed to me to be something that investors might prefer, as it meant that my fees were tied a little closer to the performance of the portfolio. If the value of the portfolio rose that quarter, I’d make more, and if it fell, I’d make less – which is about as close as I could get to charging any kind of easily scalable “performance fees” when it came to non-accredited investors. Also thought quarterly billing would underscore that I wanted my investors to be thinking long-term.

Thing is, nobody cared. Really makes no difference to my investors if I bill them quarterly or monthly – but it can make a helluva difference to your firm in terms of cash flow when starting out. My investors are much more concerned with performance and bips charged than the timing of those fees…which seems obvious in retrospect, but hey, when you’re starting out, ya need all the friends you can get.

So, what seemed like a more investor-friendly billing schedule was really just something I’d over-thought. Better to get paid every month early on.

Any other lessons learned out there?

Cale Smith

Some follow-up thoughts and clarifications from the webinar last week:

1 – The VA (virtual assistant) firm I use is www.MyAspirant.com. $10 an hour, can handle all sorts of things including HTML edits, highly recommended.

2 – Below is a video from my accountant, also highly recommended, who does everything remotely for me. That includes all entries in Quickbooks (I use Quickbooks Online) and all invoicing/receipts at the end of every month/quarter. You can reach Terry Santore directly at www.quicksilverbusinesssolutions.com or (910) 202 -3955.

Cannot tell you how nice it is to have someone responsive, competent and tech-savvy handling the books. I just email Terry quick notes whenever I move money into my business checking accounts from FOLIO, send her PDF copies of the billing reports that FOLIO creates for my clients so we can track who has paid what fees in QB, and then otherwise let her update it all. Also ping her on one-off things every so often. It all works real well.

Worked pretty closely with Terry for the first month or so, just getting her up to speed on my processes and all the nuance of things, but otherwise, now I just sit back. More importantly, I do not spend any time at all worrying about updating QBks. Which, again, is very nice. And if you get the old surprise compliance audit, you can bet your arse they’re gonna want to see your books. So, peace of mind there, too.

3 – The “GTD” I referred to on the webinar was “Getting Things Done” – a personal productivity philosophy of sorts that a friend in Silicon Valley recommended to me a few years back. Here is the book that started it all on Amazon, though there is a ton more online about GTD via Google. And here is the site. The good news is that while GTD can take a while to master (and I certainly have not), you can pick up the basics pretty quick, and even those can have an immediate impact on your business – and sanity, too.

4 – FOLIO charges my investors and I 30 bips, but has a $100 a year minimum fee, too…so the way the math shakes out is that for every account I have that is under $33,333, FOLIO charges them $100 a year, and anything over, they take the 30 bips. There are breakpoints at FOLIO, too, at $250k and $1M, so fees go down to 20 bips and then 10 bips. And using the windows at 11am and 2pm, all trades are free.

5 – That point in #4 also leads to the issue of subsidizing accounts. FOLIO is going to get paid no matter what. So if I bring on an investor with a $5,000 account, then as per the above, FOLIO will charge them $100 per year…which equates to annual fees of 2.0% – and I haven’t even gotten paid yet. On a $2,500 account, the investor is paying 4.0% to FOLIO right out of the gate, and so on.

So you may need to actually reimburse or subsidize a small client’s account with x dollars per quarter so the effective expense ratio they are paying is fair and/or reflects the terms of your Investment Advisory Contract with that investor. To be clear, everything and anything when it comes to fees is disclosed to the investor upfront – and subsequently every month in their statements from FOLIO – but just disclosing a 4.0% fee (to stay with the above example) is not enough to me. You’re a fiduciary, man. It’s your job to make sure your investors aren’t getting charged a single penny in excessive fees, regardless of whether or not it has been “properly disclosed.”

My point on the webinar was that it can sometimes make sense to take on a very small account because assets attract assets. For instance, if the world’s best tarpon fishing guide here in town wants to invest a little with me, and I know that he routinely guides for several billionaires, and that he likes to talk a lot, then I am going to subsidize that account every quarter with a smile on my face. That sort of thing.

And originally, I had a plan to service even those smaller accounts profitably, with no subsidy involved, which entailed lumping all of those smaller investors into an investment club I created just to invest in my Spoke Fund. (FOLIO can service accounts for investment clubs). Then I would become a member of that investment club, too. If I seeded that club with $33,333, then every other investor no matter how small I brought on would be profitable to me and require no subsidy…because all fees were assessed on the pool, not the individual club members.

But, I never went anywhere with that idea. It was going to cost me more to make sure I could do all that from a compliance perspective than I thought I’d make in fees from rolling all that out.

Better in my mind to know upfront just how much money you’re willing to put towards subsidizing small accounts, and having defined criteria for the investors you would do that for…and then sticking to that after you launch. I happen to have six accounts I subsidize, but each one has since referred other bigger investors that more than make up for that subsidy. My hunch is that others have similar experiences, too.

6 – And lastly, alas, I’ve got bupkus saved from that webinar. Not even any audio.

If there is interest, though, I’m happy to do a quick conference call to go over any pending Q&A from that slideshow.

Next week will be tough, but let me know and we can do something on a call the week after, eh?

Thanks!

Cale Smith

My apologies. It appears the actual recording of the webinar didn’t take. Ugh. Here are the slides from Monday’s webinar, and please let me know of any questions. I’ve got a few from after the webinar that I’ll type up soon as posts here, too.

Thanks again to everyone who joined, and sorry about the lack of a replay.

Steve Kiel is @Arquitos and @HayekFund.

Kevin O’Reilly is @kporeilly and also tweets @Camelback Fund.

Cale Smith is @CaleintheKeys and @SpokeFunds.

And here are a couple of Twitter lists of possible interest:

Cale’s Value Investors list and the Spoke Fund® Managers list. Here’s Kevin’s Spoke Fund® list, too.

Originally posted on CaleintheKeys.com in Feb. 2010.

Q. Can you comment on what the advantages of starting a Spoke Fund are vs. a mutual or hedge fund? Potential drawbacks?

A. Advantages of a Spoke Fund® compared to a mutual fund would be much lower start-up costs, more flexibility in investment style and strategy, easier administration, more transparency and lower opex. A drawback might be that it’s a direct sales model, so it can be harder to attract assets than, say, when paying an army of brokers to sell your mutual fund for you. I think that’s better for investors, mind you – lower costs, less conflict – but it is unequivocally a different kind of marketing. Think Geico versus State Farm.



Same advantages compared to hedge funds, with the exception of the investing style one…can’t short in a Spoke Fund®, or at least not using FOLIOfn as a custodian. Not an issue for me, but could be for some. The biggest advantage a Spoke Fund® has over a hedge fund, though, is that you can advertise. I suppose a comparative drawback would be that it’s not nearly as lucrative…at least not in terms of income. But, hey, few things are…and depending on how much you invest in your own fund, it may be a non-issue for you, too. Probably a whole different philosophical discussion in there related to that.

Q. I’m an investment adviser on the other coast (California), and really like your idea of a Spoke Fund. Do you use Folioinvesting or Folioadvisor? How much do they charge you and your clients? Do you still think this is the best way to set up a spoke fund?

A. Thanks for reaching out. And yes, I use FOLIOfn’s Advisor platform for the spoke fund.

FOLIOfn’s fees for me start at 0.30% per account and ratchet down at certain breakpoints depending on size of account. And to date, I still think FOLIOfn is the best option. That said, always looking at others, and hope to post more should I find anything real useful. And if you and your clients get a better deal from FOLIOfn than I do, by all means let me know!

Q. How do I start up an investment advisory business like yours? I am essentially trying to set up a partnership fund similar to what Buffet did in his early days. Like yourself, I am planning to put a significant amount of my own savings in the fund (six figures also) but will focus on investing for friends and families only – at least initially. Fund size would likely be less than $1 million.

Also, if I want to plow back my investment management fees into the fund (like Buffett did), do I technically have to flow thru the $$ from the funds to the advisory LLC and back into my partnership? Doing that would require me to sell shares. Is there a more efficient way to increase my ownership stake in the fund from the fees that I earn? My style will be long-term oriented so I do not want to buy and sell securities unless warranted for valuation purposes — and even less so for compensation to myself!

A. On the legal structure thing…does not apply to a Spoke Fund® – at least in the sense that you don’t need to go form another LP. The core of the Spoke Fund® is simply a regular taxable brokerage account in your name, set up on the Folio platform once you’re a registered investment advisor (RIA).

So your investors are not purchasing shares in a mutual fund, nor interests in a partnership…they’re buying shares in the companies themselves that are in the portfolio.

Doing it this way is actually more tax efficient for you and your investors, as opposed to forming a hedge fund as an LP, having to issue K-1s every year, etc. In a Spoke Fund®, you have very granular control over the tax lots in your and your investors accounts (more on this in a bit), and the custodian Folio tracks all taxes, issues 1099s to your investors, etc. You don’t have to lift a finger, and all the tax issues are taken care of for your guys. In that sense, you won’t get taxed until you sell or receive a dividend…just like a normal taxable brokerage account.

On reinvesting your fees…it’s simpler, too. You get paid as often as you want (I do quarterly billing) and fees are automatically deducted from your investors’ accounts by Folio, according to the fee schedule you work out with them and disclose to your clients. Those fees go to your business’ house account, and come in as revenue to the firm, at which point you can pull them out as salary and then just invest them back in the core portfolio through your own personal account that is set up just like another investor’s account would be. So, there is no need to sell more shares or another interest in the partnership…just add profits to your own spoke account and you’re there.

Q. Why did you choose to go with a separately managed account approach instead of launching a registered fund or hedge fund? Clearly the Tarpon Folio gives you a bit of the best of each. Still, you don’t get to share in any of the performance (except through incrementally higher fees).

A. Here’s the long version:

http://www.caleinthekeys.com/2009/05/why-i-built-a-spoke-fund/

Short version…wanted to build a business that I’d actually want to invest in. Mutual funds = broken – for both investors and PMs. Hedge funds = no moat and no marketing combined seemed like poor odds out of the gate, and being on an island certainly wasn’t gonna help me.

Thought about a Buffett style partnership for a long time, but in the end, thought it was unlikely to work out well for me given my circumstances (down here, no prior public track record as PM, not tied into enough HNW circles, etc). Kept chewing on an alternative until I landed here.

Performance fee thing was a nut I couldn’t crack. Law seemed pretty clear that you could only use ‘em with accredited investors. And practically speaking, billing for performance fees was going to be a big pain. Couldn’t scale that part – at least not with FOLIOfn and just me in the shop.

And I basically subsidize smaller accounts. Had a way to service them profitably, but in the end was getting to be too much of a pain. Even if it costs me $100 a year, cheaper than acquiring them some other way. Plus, assets attract assets, ya know?

Irony is that the only way to lower the minimum profitably is to raise your AUM fees, so to let a lot of small accounts come in, you’d have to charge them more. And that doesn’t smell right. But FOLIOfn does fractional shares, so even my waitress friend who wants to invest $1,000 tomorrow can still own a piece of a share of Google at $440, along with pieces of every other company in the portfolio, too. So, the accounts I subsidize end up being a fantastic deal for little guys. Just can’t build a business around them exclusively.

I’m thinking of it all like open source software at this point…put the code out there on the blog and see what happens. Should others find it and run off to create their own Spoke Funds, awesome. If all it ever does is get people thinking about what a rip most mutual funds are, that’s okay. But if it happens to completely change the face of Wall Street as we know it and spark a global movement of epic proportions that makes the managing of other people’s money a noble and dignified profession again…well, I’m down with that, too.

Q. I’m a value guy RIA – left a bigger boutique firm, moved and hung out my shingle. I went from planning to start a hedge fund w/ family/friends money just in time for the market to crash, everyone to start hating hedge funds, and having 2nd thoughts personally about the fairness of the hedge fund model and my management style’s suitability for that format. Since I am a value, long only, long-term guy why did I have the right to charge hedge fund fees? Not that that has stopped a lot of other folks….

So I was interested in your Spoke Fund® idea. I too looked at the mutual fund structure and agree it is a joke and of course the industry as a whole is a joke. That has long been one of my main motivators in this business, having come into it from a science background 12 yrs ago. Nowhere else does an industry charge so much to destroy so much value. I read your posts on spoke funds, and would be interested in any additional info you have on the structure. It appears that it simply automates trading in all accounts based on trading in the central account? Anything more to it than that? Doesn’t seem so based on your funds’ website. What I really like is the potential to manage small accounts, which was one of my early goals since the small investor is so poorly served. Yet the typical RIA structure just makes small accounts uneconomical. The spoke structure looks to be the answer….

A. Yeah, it’s not much more complicated than you gathered. Don’t know if you know the guys at FolioFn or not, but their advisor platform basically lets you apply separately managed account principles in a scalable way. I just included all my own money in there, put some new process around it, and decided to go direct to the investor with it. Features are by far better. So, stay tuned on the old blog and will keep putting it out there. Been surprised by the reaction so far…and I’ve barely got anything up. Clearly lot of folks thinking about things the same way we are, ya know?

Follow-up Question: I did some poking around FolioFn, so yeah I got the basic rundown. Have not spoken to them though. The biggest question I have is, do you think you can scale it enough?? At 60bp net to you that is a lot of $20k accounts to get critical mass. Let’s just say you want $250k in revs, that’s 42M in AUM or 2100 $20k accts… I agree with your pricing, and I suspect Folio’s cut goes down as AUM grow. I guess Folio handles all the admin, so it is very little add’l work for you for each acct. And everything is electronic so, if you can find enough folks I guess it could work. Best of luck, still not sure it makes sense for me to give it a whirl, but we’ll see.

A. Yep, it’s scalable, but under a couple of different assumptions. First is that I’m good with revs much lower than that. Built it so I can run it all as a one-man shop with virtual assistants and contract help, and about to get a particularly nice deal on office space. Don’t need a big salary, either…most disposable income would go right back into my investment in the fund, anyways. And I’ve already got all the toys I’ll ever need.

Second is that our median account size is higher than $20k, so our overall margin is slightly higher cuz as you guessed Folio’s slice drops off. Would be an interesting study…how many folks I’ve waived our $12K minimum for, only to have them refer a HNW type. The Keys are funny like that. Assets attract assets and what not.

Third is that there will be some heavy spend on sales and marketing in the Keys, which we’re now starting to get into. Lot of local economies of scale I’m finding, which is translating into some solid ROI.

How well we do will be related to our marketing, which almost goes without saying…but I find it odd that the three professions – medicine, law and finance – are each so horrible at doing it. I’m no expert, but I’m getting better. So, game on.

Q. Let me first offer my sincere thanks for offering to share information about how to go about simply doing the portfolio management without getting bogged down with too much outside activities. I do love investing and am passionate about it. I am trying to research how to go about starting an asset management firm. I read lots of thing and came to conclusion that I can go with individual portfolio management style but that also requires doing lots of thing which adds cost for you and ultimately for your clients. I stumbled upon your site and found the articles written by you so far very interesting and although I don’t know how to go about this, if you can share further information it will be really helpful for me.

I saw the post which had “My next post in this series will identify the critical path activities that I think most deserve your initial attention.” I am waiting for the information and if you have it documented I can’t wait to read it even if it’s in raw format. I really appreciate folks like you who are ready to share information with others.

A. Here’s that post!
http://www.caleinthekeys.com/2009/06/building-a-spoke-fund-critical-path-items/

Q. I started following you on Twitter a while ago and really like your approach to your business. I think the Folio approach (hub and spoke fund) is a great way for the retail investor to get all of the positives of a managed portfolio and a manager, with very little of the negatives. I am a retail Financial Advisor and have been in the business for 18 years. Some day (maybe soon) I would really like to be doing what you are doing. I really appreciate the way you have posted all of the steps that you took to set up your business.

It has really been helpful, but I still have a couple of questions. Before you started to manage other people’s money, how did you establish a track record? Do you get your results audited and if so, how and by who? Thanks in advance and keep up the good work!!

A. Thanks for reaching out! Hope to put more out soon on the blog about a Spoke Fund® from the portfolio manager’s perspective. In the meantime, fire away with questions anytime.

I’d been an analyst for some time prior to starting my own firm, but I did not have a public track record I could point to being solely responsible for as a portfolio manager. The friends and family who originally invested with us knew of my success in the general sense that came from managing my own family’s money for some time, but I never tried to formalize that.

Professionally, I had buy/sell recommendations I could point to, and annual returns from a small hedge fund I did research for a few jobs back, but they weren’t reflective of just me by any means.

So, I haven’t used anything when it comes to citing a prior record. The question comes up, obviously, but our funds simply won’t have three year track records any earlier than three years. Irony is that I’m finding most people so far don’t care. You’d have to ask them, but I think the fact that my family’s net worth is in the funds I manage might speak to a level of conviction that a track record alone doesn’t address.

That said, had I had a decent public record prior to getting going, we’d probably be ramping assets sooner, but the pace to date is okay with me.

Q. We were not able to locate prospectus for below-mentioned fund on your Internet-homepage. Could you please provide us, by e-mail, with the prospectus and SAI (statement of additional information) of your funds?

We are especially interested in the legal aspects/forms of the funds – e.g. if it’s about Limited Partnerships or Limited Liability Companies. May we kindly ask you to indicate to us (or if available, of course to provide to us) whether there are any subscriptions documents are available when a client/customer wants to invest? Furthermore, we would like to know if the funds contain special liabilities like capital calls or clawback clauses.

A. Different animal. A Spoke Fund® is not a hedge fund. We are basically taking a separately managed accounts approach to managing a single strategy. It’s better for our investors, and easier for me as the portfolio manager to administer. We call the model a “spoke fund.” It’s all invested in listed securities, and there are no capital calls, clawbacks or any other silliness. You own the underlying shares directly in a secure account held by our custodian. I simply manage it from there.

There are no subscription documents, but we do have an investment advisory contract that our investors execute. That agreement among other things grants us approval to set up an account for the investor at our custodian and gives us full discretionary authority over that new account.

The process to invest consists of three steps.

1 – Investor provides basic background info to us, via phone call or online sign-up form. That form can be found by going to the http://www.islainvest.com website and then clicking on the “How to Invest” link in the Quick Links menu at left.

2 – We’ll incorporate that client data into our standard investment advisory agreement, a document that is sent via email for execution by all parties using electronic signatures.

3 – We open a new account for the investor at our custodian, FOLIOfn. Then we’ll provide the investor with instructions on how best to transfer assets into the new account. Once the assets arrive, I’ll invest them in the Tarpon Folio.

We can handle any manner of traditional account (individual, joint, revocable trust, business) and tax-deferred accounts, too, including IRAs.

Q. Two questions. I contacted the FolioFN guys and they told me that each client has to pay $290 a year. It seemed very high to me especially for the clients having very little money. I saw that you had 0.30%, 0.20% and 0.10% deal with them based on total assets under your management. Did you get some promo deal or negotiate?

You are doing fantastic job to educate people and have been inspiration to me to start, which is in the best interest of clients as well. That’s the reason I am trying to dig information. I really appreciate your time and reply.

A. That Folio fee thing sounds odd – are you sure you’re talking to the institutional guys and not the retail folks?

And there is no such thing as a prohibition on publishing performance results that first year – assuming, of course, that your returns as shown from inception through the year-to-date. The regulators distinguish between recommendations and actual performance, and you’d probably want to clarify the rules around the former with counsel. As far as performance, though, while you’ve got to be sure to disclaim everything, that’s all the time, and not just the first year. Believe me, I’ve paid the lawyers enough by now that I’m confident our compliance is solid across the board.

Q. I have read all the info on your site about spoke funds and am still somewhat vague on the details. I see you can buy fractional shares. I am assuming that you have some way of trading these fractional shares, or are they just the percentage the investor owns in the hub set of funds?

Actually, that doesn’t make sense either, since as the hub grows with new investors my share percentage would decrease. Is there some tutorial on how the hub and spoke fund works for each individual investor? I am aware of hub and spoke structures as a way of off-shoring investments, but this seems quite different.

A. Our custodian FOLIOfn allows us to buy “fractional shares.” Everyone is subscribed to the same portfolio weightings (say, 9.0% in Paychex, 5.2% in Google, etc.) and with fractional shares all those percentages can stay exactly the same across everyone’s accounts. Eliminates the problem of, say, only being able to buy whole numbers’ worth of shares for companies like Google that trade at $525+.

There is no impact on your ownership of anything based on new investors coming into the fund – or leaving. When everyone comes in, they are independently subscribed to the most recent portfolio weightings I have established (as opposed to whatever their current market-based weights may be). So, you own shares in the same companies we all hold, in the optimal percentages…as opposed to owning shares in a third party entity, like you would at a mutual fund or hedge fund. Then your returns would be impacted by others’ actions. But, this way it is not.

You can also think of it like this…the Spoke Fund structure is a way to link all investors, including my family, to the same identical “model” portfolio – only the “model” was funded with real dollars within seconds of being created. So, a change to the core model changes everyone’s account the same way, and at the same time. Fractional shares allow us to own more of the companies we want to in a simple, pragmatic way.

Follow Up Question: Ok, I think I understand. When new money comes in, say $50k or $100k, the investor would get the same percentage weighting as the other investors, it is just that their number of shares would be proportionately greater. Right?

When you buy/sell into the core account, I would assume that would affect all the percentages of all the members individual stocks, including the stock you just sold and bought new, and their fractional shares would change. Do I have that correct?

A. Yes on the first question…percentages stay the same, but shares would be greater.

On the second question, not sure I follow ya, but as I read it, the answer is “Yes, except we minimize meaningless trades.” By that I mean that when I make changes to the core account model, I have thresholds I can set to eliminate small onesy-twosy trades in investors’ accounts whose real-time portfolio weightings already closely resemble the optimal portfolio weightings in the core model.

Say I have a Google weighting of 5.25% in the core model. A month later I want to adjust the core model position in Google from 5.25% to 5.00% and at the same time increase CarMax from 5.0% to 6.0%. So, I can tell the system to (1) only sell Google shares in an individual account if the real-time weighting in that account is more than, say, 0.25% different than the new weighting in the core account, and then (2) don’t do anything if an investors’ individual account is already within 0.15% of the new 6.0% core model weighting in CarMax – which could happen based on when the investor came on board and initially bought CarMax, as compared to the core account.

Ton of criteria I can use, but the point is that I set them up to try and minimize redundant and/or silly trades. Not perfect, but still pretty good…and much better than a mutual or hedge fund.

This part help explain that second question, too, at least as I read it originally. Otherwise, might just be FYI stuff:

All buys and sells are done either in the open market, or within FOLIOfn’s internal clearinghouse, after it looks for better pricing among all institutional clients. Here is an example:

Say I want to buy shares of GE in the portfolio. So, I make GE a 5% position in the core “model”, and tell the system to automatically execute the orders in everyone’s account to bring each individual’s account in line with that 5% position in GE as well.

If I decide to buy those shares during one of two “windows” during each day that FOLIOfn offers, then we can buy those shares without paying a commission. (I have always used “window trades” to date). During those windows, FOLIOfn matches up all my clients’ buy orders for GE, and sees how many other institutions on its platform are selling GE during the same window. Then it compares the pricing on those internal-to-FOLIOfn-shares to ones it can get on the open market. We get the shares that are the better deal for us…meaning the cheaper ones, obviously…and every account buys those shares at the exact same price. (That’s another reason for fractional shares…so everyone gets the same pricing and there is no post-trade allocation).

So, I make a change during a window, FOLIOfn finds us the best pricing either internally or on the open market, then everyone’s accounts automatically update to reflect that change – within pre-determined tolerances that are meant to minimize small, meaningless trades among individual accounts.

Second Follow Up Question. Thanks for the prompt replies. Here is how I think I understand: There is a large core account that is composed of your and your family’s money. This money is invested across a diversity of individual stocks. As a new investor sends in money, a Spoke account is created where their money resides and is invested in the same stocks at the same percentages as the core account. When you want to make a change in the core account – e.g. reduce one position in order to increase another position or even to take a new position to add to the core – something automatic happens and all the Spoke accounts get adjusted proportionately and the stock change happens everywhere. Since all Spoke accounts are fully invested (probably as the core account is) to take a new position would pretty much always require reducing another position(s) to pay for the new one. Then everything happens automatically in the core and all spoke accounts. OK so far?

Now, the next question. Suppose I need money out of my account at some point. Do you sell off across all positions to keep the percentages the same so as not to unbalance everything between the core and the spoke? This seems like the complicated part.

A. Yep, think you got it there. And on the withdrawing money part…yes, I will sell off across all positions to keep the percentages the same. There is also a little wiggle room in the cash that is held outside the portfolio. So, withdrawals have not been an issue between both…can raise cash and/or take requested funds out pretty easily, and without disrupting anything between that account and the core account.

Q. Cale – Thanks for the info on this blog and congratulations on Gecko and Tarpon results. I am considering starting a spoke fund in Texas and have a few questions for you.

4) Are there other required/necessary documents to run a spoke fund beyond those provided by RIA in a Box?

A. Good questions. In quick order, then…

1. On the FOLIOfn platform, a Spoke Fund® is a model portfolio that is synced to the manager’s account quite literally within seconds of creating the model. That way there is no difference between the model and the manager’s account in terms of cost basis, future tweaks, fees, performance measurement, etc. In my case, that account is in my name, and though you’d want to verify the tax effects, there is no reason it couldn’t be in your company’s name. So that “hub” concept probably won’t resonate with FOLIOfn reps yet (working on it!), but it doesn’t need to, either, for you to set things up the way you want.

That said, been kicking the tires on setting up a spoke fund using Interactive Brokers lately, and in that case, it appears the hub there would actually be an account. No real difference from either my or the investors side there than at the FOLIOfn back-end, but my interest was piqued due to lower costs….IB costs appear lower on more accounts. Couple of other things need to be checked out over there, and some IB features are not as user friendly for investors, but I hope to summarize and pass on info at some point.

2. Yes, all fees apply to the manager’s account(s) as well. I charge myself the same thing I charge all my investors. Right thing to do.

3. Registration requirements are very much state-to-state. A good rule of thumb is that once you have more than five investors from one specific state, you’ll need to register there as well. Doesn’t work for all states, though. Practically speaking, that may mean you only take on bigger accounts from out-of-state to more quickly recoup the costs of registration there. RIA in a Box can definitely help register wherever you need.

4. RIA in a Box can also help with all the regulatory and compliance documents you will need to get up and going. (They should be paying me for these plugs!). Highly recommend them.

I’ve also used lawyer Todd Schwartz (just started his own firm, Schwartz Law Group) for help on things that I needed definitive answers from a lawyer on, as well…the content of ads, disclaimers, reviewing online materials and a handful of other one-off things basically related to the marketing of Spoke Funds®.

That said, there are plenty of other documents, spreadsheets, and/or process-related things you’ll need to actually run a fund. I consider all that to be “Operations Manual” material, and while some of that will be specific to your business, there is quite a bit that all spoke fund managers using FOLIOfn, for instance, will have in common. Not quite ready to post my manual online yet, but suppose I could be convinced to some day.

In any case, that’s exactly the sort of thing that makes me think I should have some kind of informal get-together with guys like yourself here in the Keys at some point this spring. Think folks could get a crash course in all of this without having to wait for me and/or my Operations Manual. Love talking about all this, but also gotta keep my primary job front and center. Blowing it all out in a weekend would probably be much more efficient for everyone.

Q. I was really excited to read your blog on “building a Spoke Fund” as I had been researching the ins and outs of starting my own hedge/mutual fund. I’ve read and reread your blog and have been on your site for your fund and was really impressed with what you put together. I know you must be very busy but was wondering if you could answer some questions or point me in the right direction to get the answers I need.

Thanks in advance for your response.

A. In short order…

1. Easiest way to answer that first question is here:

http://www.caleinthekeys.com/2009/05/why-i-built-a-spoke-fund/

2. Still looking for a good (read “competent and cheap”) auditor. Trying to find an auditor in South Florida – ground zero of what seems like Ponzi scheme central – has been challenging to say the least. The local firms I’ve talked to are saying they’d have to go get additional insurance, which puts the costs way too high. It’s not like I trade much, so verifying returns thru a bigger firm up north simply won’t take that long…but they want to charge like it does. In any case, my next call about this will be to a firm in Chicago that comes well-recommended.

In the end, though, I may just post all statements, tax forms, and trade confirms online on the blog or something, so anyone can verify things all by themselves. I suppose an audit would be quicker and have the patina of a third party endorsement…but if the purpose of an audit is transparency and verification, it sure seems like posting all statements online would do the same thing.

An audit isn’t as much of an issue in a Spoke Fund as a hedge fund in any case, because each investor can log-on anytime, day or night, to see their funds and returns. But I recognize I’ll need to do it at some point, anyways, though the cheapskate in me cringes.

If you’re aware of any good auditors, though, I’m all ears.

3. Boy, I’d like to write an ebook. A year ago I thought I’d have it done by now…but the reality is I’ve barely started. Hope to fix that before too long.

4. FOLIOfn will let you go long any listed domestic stock. So anything other than plain vanilla investing wouldn’t work on FOLIOfn. That said, I’ve been kicking the tires on Interactive Brokers a bit, and that may give us more options. Stay tuned.

5. There’s the business breakeven, and the account breakeven. Both can vary a bit based on the variables involved, and I need to get more in the weeds on this for everyone, but in general, given all my variables, I will be fat, dumb and happy at $20M in assets. We’re at about $7M right now, after a little over a year, so I’m confident my girth will be increasing.

Q. Thanks again for giving up some of your time to help a young aspiring Spoke Fund manager. Almost done studying for the Series 65, although I had to take a small break due to some training (I’m active duty military right now).

Once again, thanks for all the help. If I bug you too much with these questions (I’m sure I’ll have many more), let me know. Thanks man.

A. Here are some rough numbers as I think they might apply for you, based on reviewing my own firm’s financials at the end of the year:

Advertising = I spent almost exactly $10k in 2009. This will go up in year two…but I should also get a better return on that money, too. Lot of local advertising lessons learned last year.

Legal fees = I paid out a little over $8K – but will be about $500 total in 2010, I’d say. I spent what felt like a ton of money on lawyers and compliance guys on things specific to spoke fund model and compliance set-up (i.e. mock compliance audit, etc). So, one-time in nature…and if I can communicate things well enough, you won’t need to spend that money, either.

Office expenses = About $5k…but also includes a ton of one time things So, again, lot lower in 2010.

Stationary & printing = about $1500. Probably will go up 50% this year.

Research = Call it $5,000. (I spent twice that in year one but will halve that the next year). Then will be static…costs of a ton of different subscriptions.

Phone, IT & Internet = $2500 (includes webhosting, cell, office, and handful one-time set-up fees).

Figure about $2000 in licenses, travel, client meals, civic group dues, etc.

So, as a baseline, around $25,000 in opex is probably a reasonable bogey for a first year, truly from scratch Spoke Fund® (i.e. no pre-existing clients) – and assuming you advertise as heavily as the above, and pay up to read everything you can get your hands on. You could run it very light at $10K a year if you come with client relationships already in place, work from home with the office gear and get selective on research.

Don’t really need an office that first year if you’ve got coffee shops/restaurants nearby…but after about a year people will start to look at you funny if you’re still working out of the home. I jumped a little early cuz I got a great deal on an office lease. And I would pay up for a good web site, logo, and presentation folders (in “stationary” above)…skimping there shows.

Also, cash starts kicking in the first quarter you get a client, so it’s not all necessarily coming out of pocket. Probably best to plan like it could be, though. You’ll also note the above assumes no salary in year one, and though that will change in year two over here, I leave that particular line item up to you.

Any other questions? Post ‘em on the boards!

Cale Smith

The above was the title of a recent article in the Wall Street Journal that I thought was potentially relevant for future Spoke Fund® managers. According to the author, these were the top ten mistakes:

1. Going it alone.
2. Asking too many people for advice.
3. Spending too much time on product development, not enough on sales.
4. Targeting too small a market.
5. Entering a market with no distribution partner.
6. Overpaying for customers.
7. Raising too little capital.
8. Raising too much capital.
9. Not having a business plan.
10. Over-thinking your business plan.

All good things to think about, even though I might mildly disagree with a few, and add a few others when it comes to Spoke Funds. Do read the whole article for much more on each bullet above. Anything else that should be added?

Cale Smith

I received this via email last weekend:

“I came across your site online. I run a hedge fund but am always looking at other structures. I am attempting to understand how your spoke model is different then separately managed accounts (which I also have in place).”

The gist of my response was this:

“I’d say the key distinctions from the investor’s point of view are that (1) a Spoke Fund® contains the majority of the manager’s net worth (meaning in the SMA world that it’s all in one of the accounts, too) and (2) it’s run by a true fiduciary.

From the business owner’s point of view, the key difference is probably that you’re marketing it directly to the retail investor.

From the manager’s point of view, there’s probably much more in common than not.

Handful of other minor differences, but it seems those first two are the big ones – to investors, at least. And that to me is the most critical part.

Here’s a post I did a while back on the differences, too:

http://www.caleinthekeys.com/2010/07/spoke-funds-versus-smas/”

As per that prior post, in the end, I’d say it’s oranges and tangerines – same class, different species.

By Cale Smith

Below are links to some of the original posts I wrote that seemed to generate the most interest from other portfolio managers curious about spoke funds. I suspect I’ll need to refer to these in the future on this site, so here they are:

What Is a Spoke Fund®?
Why I Built A Spoke Fund®.
How to Think About Running a Spoke Fund®.
Building a Spoke Fund®: Critical Path Items.
Spoke Fund® Comprehensive Q&A.

And this is the original movie I made that seemed to get some attention, too. I created it in PowerPoint, recorded it in ScreenFlow, and published it on YouTube.