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The giant custodian will hold many of the assets itself
April 22, 2010 — 7:13 AM UTC by Brooke Southall
After a year of tension with many of its biggest, most loyal clients, Schwab Advisor Services has a system for handling alternative investments that it believes is the best in the industry.
The San Francisco-based asset custodian had dozens of RIAs complaining bitterly last March after it abruptly changed its policies regarding the custody of hedge funds, private equity and other investments from outside the mainstream.
With advisors expressing so much displeasure, the company has been contrite and mostly quiet on the subject of alternative investments.
But now Schwab has a system of holding alternative investments of behalf of financial advisors that it believes is good enough to boast about.
“We’re there and nobody else is,” says Bernie Clark, executive vice president and head of Schwab Advisor Services. “Our competitors are still treating this [custody of alternative assets] as an accommodation.”
He adds: “We are accepting [investments] based on the merits of the assets rather than the merits of the advisor. [The new system of handling alternative assets] is replicable and scalable.”
Fidelity Instituional Wealth Services’ spokesman Steve Austin had this to say on the subject: “We understand alternative investments are an important part of most of our clients’ businesses and we continue to work with them in this area.”
TD Ameritrade and Pershing declined comment but recently Mark Tibergien, CEO of Pershing Advisor Solutions, was outspoken on the subject in this article: Pershing is working to create a better alternative assets experience
Pershing released a list of nine protocols for vetting alternative investments in September and it’s given the company a competitive advantage against Schwab, according to Tibergien.
“Since then, 10 Schwab advisors have opened up new relationships with us with the alternatives platform as being just one of the reasons — the other is that they wanted to diversify their custodial choices and they felt we were clearly different from the three retail-oriented firms,” he said earlier to RIABiz.
Schwab has come back with its own system no doubt designed to counter these kinds of competitive threats. Here are nine qualities of Schwab’s new alternative assets program:
- Schwab’s asset acceptance review process — initiated last year to help it evaluate new positions for alternative assets already on its books — is now a permanent part of the process for custody of these investments at Schwab.
- Effective May 3, Schwab will accept certain kinds of new alternative assets for custody that pass its asset acceptance review process, including: domestic funds, offshore funds and registered REITS and private stock that meets certain criteria. Schwab formerly said it would not custody any offshore investments.
- As of May 1, Schwab is increasing its annual maintenance fee per position and lowering its transaction fees. The annual fee is now $100 per alternative assets position, but has no limit on fees that can be charged to an account. The new annual fee will be $250 per position, but the advisor’s fee is capped at $500 per account. For transactions, the fees have been $250 for new purchases transactions and $100 for subsequent purchases. On May 1, the transaction fee drops to $100.
- The increased revenues from handling alternative assets will go toward resources and upgrading systems to provide a better client experience through upgraded technology infrastructure, according to Schwab.
- Schwab keeps custody of nearly $6 billion of alternative assets held in about 12,000 positions. About 33% of Schwab’s RIAs hold alternative assets in their accounts.
- For assets that Schwab declines to hold on its own books, it will refer to alternate custodians — Millenium Trust Company and Sterling Trust. One major category of such assets is private debt, which includes promissory notes.
- Many RIAs complain about holding assets outside Schwab because it means that their statements and reports aren’t consolidated. But by June Schwab plans to roll out an interface that will enable it to provide data downloads from both Millenium and Sterling that are compatible with most portfolio management software.
- Later this year or early next year, Schwab will begin to analyze and review for compatibility assets already in custody at Schwab to ensure they pass its asset acceptance review.
- Schwab now has a live connection to the DTCC’s AIP [alternative investment products] platform and ready to receive position and valuation files from issuers; it has hired an employee to support AIP adoption and will be advocating for participation in AIP throughout 2010.
Though Schwab’s ability to handle alternative assets is undergoing a radical transformation, there are still wary financial advisors like Malcolm H. Gissen. He manages an eponymous RIA that manages $250 million of assets from San Francisco, and Gissen isn’t sure if the new program will help him or not.
His company has developed close relations with Canadian brokerage firms that allows it to participate in pre-public offerings. Gissen’s expertise is in investing in resource companies and it helped him to earn recognition from Morningstar, separately, for his Encompass Fund as the number five mutual fund of 16,000 funds in the United States in 2009 with a 137% return. It was also the number one world stock fund in 2009, according to the Chicago fund tracker.
“When Schwab says we can’t put these restricted stocks with them, it presents a problem for us,” he says. “There were a couple of offerings we just had to pass on.”
In response to this issue, Fidelity has aggressively courted his firm and told him that they can hold the stocks, Gissen says. TD has also made overtures.
Gissen is still holding out hope Schwab’s new system will accommodate him – though if it doesn’t he’s prepared to make the switch.
“If that’s the case, we have no choice but to open new accounts with other custodians,” he says. “This is a significant hassle to get signatures, monitor accounts not at Schwab and combine reports of Schwab and another custodian.” Gissen uses Schwab PortfolioCenter as his portfolio accounting system.
It’s likely that Gissen will be able to successfully hold his assets with Millenium, Clark says.
Other RIAs like Jim Berliner, president and CEO of Westmount asset Management say that Schwab’s new system is all but certain to solve their alternative assets issues. “This will work for us,”’ he says. The Los Angeles-based firm manages about $1.1 billion of assets. About 25% of Westmount’s assets fit the ‘alternatives’ category and about 5% of all the assets – mostly hedge funds of funds — were concerning to Schwab.
Berliner believes Schwab did the best it could under the circumstances.
Handed them lemons
“The situation handed them lemons and they didn’t turn it into lemonade but they made it as sweet as they could under the circumstances,” he says. “I think this is the biggest challenge they faced in a decade.”
Clark says that for him it’s been an enormous challenge that he’s glad to be finally putting behind him.
“To me, it’s a huge deal,” he says. “We could have served [clients] better and now we can and they can grow.”
Clark says that Schwab’s decision to put the brakes on some alternative asset custody that occurred last year resulted from a confluence of events that didn’t hit other firms the same way. There was a continuing acceleration of the use of the investments by Schwab RIAs and — as the market leader — the number of positions was far greater at Schwab than elsewhere.
'Yes’ or 'No’
At the same time, there was an abrupt shift in the financial markets and regulatory atmosphere. Schwab didn’t have a real platform to accommodate the growth and it made the decision to call a timeout. “We had to do something about it…People just wanted 'yes’ or 'no’ on our capabilities and we came to this [new program] slowly,” he says.
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