Portfolio manager Cale Smith’s riffs on investing, spoke funds, and Islamorada in the Florida Keys.

I’ve had some back and forth lately on another site about the differences between a spoke fund and a SMA, or separately managed account. You can find the trail of comments at the bottom here. Well, except for the first comment, which I deleted, because I thought the poster was a crank.

In any case, he does have a good point – in nothing that I have put out is it clear how a spoke fund differs from a separately managed account. While I don’t think most investors care at all about the differences, apparently at least one pseudo-anonymous broker does, and I suppose there could be other folks with a similar point of view. So…

Spoke Funds versus Separately Managed Accounts

Here is a good overview of SMAs. You’ll note that many of the advantages of investing in an SMA are similar to the advantages of investing in a spoke fund – specifically, individual cost basis, direct ownership of shares, and portfolio customization. While I’d have to defer to an SMA expert to clarify this, I’d also be willing to assume that there are probably key similarities in technology, trading, and portfolio administration.

However, there are some key differences between the two as well:

- SMAs are sold by brokerages. Spoke funds are run by RIAs.

- SMA managers may or may not have a fiduciary responsibility. They may in fact be legally bound to put their employers’ interest above their investors’. Spoke fund managers are fiduciaries. They are legally bound to put their investors interests above their own.

- SMAs afford investors the ability to use multiple managers. Spoke funds do not.

- SMA investors may not have the ability to speak directly to their SMA manager. All spoke fund investors can speak 24/7 to their spoke fund manager.

- SMAs are often sold in conjunction with investment advice and/or other financial services. Spoke funds are not.

- SMAs and in particular wrap accounts have high fees, many of which are hidden. Spoke funds do not.

It’s also probably safe to say that SMA managers have little if any of their own net worth invested in the SMAs they manage. Spoke fund managers have the majority of their net worths invested in the funds they manage. This is the key factor that distinguishes the two in my mind – and to investors, too, I believe. I think the better question is not “Is a spoke fund an SMA?” as much as it is “Why aren’t all SMAs spoke funds?”

Some of the things on the list above are certainly subjective, and others might change over time. The larger point, however, is that I think there are big enough differences between SMAs and spoke funds that the latter is worthy of its own category. It didn’t have one, and after banging my head against the wall for a bit, eventually came up with the term “spoke fund.” But at this point, that term is much bigger than just me.

So, to sum up the ultimate difference between spokes and SMAs, I’d say it’s oranges and tangerines – same class, different species.

I suppose it’s possible that the better taxonomy for a spoke fund might be as a sub-category of SMA, but I’ll leave that to others. That seems to me to imply a certain deference to Wall Street, and I’ll set my hair on fire and run naked down US-1 before I kowtow to those guys.

What do you think?

Last in the series. After this in the workshop was a presentation about tech tools and social media by John Fleming, CEO of Outcome Labs, and then a grab-bag sort of wrap-up that we ended up doing over dinner later that night at Morada Bay. No slides there, just beer and yellowtail.

I think the most relevant messages I tried to get across during this section were as follows:

1 – Being a good portfolio manager is not the same as running a company that is good at portfolio management.

2 – The economics of running a spoke fund can be very compelling.

3 – The internet gives you an advantage over potential competitors – mutual fund companies, hedge funds and even brokers chasing the same clients. More specifically, you can acquire customers at a cost very near zero.

4 – Certain technological tools can also bump your productivity up quite a bit. That’s important because it allows you to keep your focus where it should be – on the fund.

Also – nothing focuses the mind more on the importance of cash flow than running a small business. To paraphrase Warren Buffett, being a small-businessman makes you a better investor, and vice versa.

Other notes on the below:

That Sales Funnel slide is one of the most important of the day. Simple concept, and probably a bit too clinical, but to have a systematic way to attract the right kind of people and have them become investors is crucial. The “10 Things to Expect” slide was basically a rehash of this blog post. And while I emphasize the online channel in discussing marketing here, it cannot replace good old fashioned gripping-and-grinning. That should be a given. It just doesn’t scale. The right mix, the right spend, timelines and everything else that goes into marketing is still very much a work in progress for me, too, so as usual, take any and all of this with as many grains of salt as you see fit.

And yeah, I would much rather not worry about marketing, ads, sales, branding, yadda yadda…but the head of my company absolutely should keep marketing a priority. And, well, that guy is me.

Here again is the link to Part 1, and a link to Part 2.

The slides below cover prepping for launch and then the actual launch of a spoke fund. The prepping for launch slides were similar to this older post on Critical Path Items. The Launch series focuses just on specifics on the FOLIOfn platform, and assumes a handful of things that may not be obvious up front – namely, that you’re going to rely on window trades to make your initial purchases. You don’t have to, and may not want to, as per these comments on a previous post. I like using window trades for the reasons outlined in that same comment thread – i.e. they are free. This brings my inner cheapskate to tears.

The screenshots used to demo the steps in the FOLIOfn back-end also were taken from one of two advisory accounts I have at FOLIOfn (different billing plans), and were from a mock portfolio that just contained three stocks. Once you understand the core process, which is pretty straightforward, launching a fund with more stocks is simple.

Also, the topics on the “Things to Note” slide aren’t really done justice here. Each is probably worthy of a separate post of its own.

There are a handful of tools I’ve developed on my own, too, to fill in the gaps in FOLIOfn’s own system. The “Prepping to Invest Client $” slide (number 25 here) is a simplified version of one such tool – a basic spreadsheet – that I use to enable me to make sure I’m investing clients money in the right proportions. More specifically…

When initially syncing a new client account to the core model, you should manually adjust the weights of individual positions to be bought in order to meet your desired target weights. That’s because the default in FOLIOfn’s system when syncing client-by-client is to buy shares according to current market weights, not the most recent weights you’ve dialed in to the portfolio. If it’s been a few months, the differences can be big – and then your clients are buying more of those shares that have gone up the most.

The ability to tweak that initial buy-in is actually another advantage of spoke funds over mutual funds, as I get into more in this post on Q&A and the Ask the Geek section of this shareholder letter.

In any case, you only need to make those weighting tweaks when syncing a new client the first time. Once they’re locked in, any changes you make to the core model automatically brings everyone in line to the most recent weights you dial in. So the bottom line is that it’s not a big deal as long as you include that step in your own onboarding processes.

And finally, I’ve recently been looking at new ways to streamline my own client onboarding process, too. So while EchoSign has been great to me for the last few years (more about them later), I may soon tweak some things beyond what is shown here. And you all will be the first to know…