One California RIA gathers about $40 million of assets monthly by tapping institutions

Name: Kevin Tanner founder, president and CIO of Saratoga Research & Investment Management (originally Tanner & Associates Asset Management)

AUM: About $760 million

Years in the RIA business: 16

For Kevin Tanner, the jump from serving individuals to also managing institutional money seems to have happened in the blink of an eye. Three years ago, a well-connected client steered business to Kevin Tanner’s Saratoga, Calif.-based firm (See: Suddenly noticed by big investors, Kevin Tanner’s small RIA is bracing for billions of AUM) and that business has begotten much more business. We asked Tanner about his firm’s meteoric growth, the challenges that attend it — such as custodian overload — and what it’s like having institutional money beating a path to your door.

In July of 2010, your firm had $240 million of assets under management, and you thought AUM could hit $2 billion within a year or two. Where do things stand these days?

In early spring of this year we hit $500 million for the first time; we’re now probably at about $760 million. We’ll hit $1 billion sometime in the next six months probably. There are several new firms coming on now and many behind that who are getting closer every day.

Some firms have told us they can’t use us until we get to $1 billion. We’ve been very, very selective about the firms we will work with. [In the past several months] I’ve said no to well over $150 million of new business. There are just certain types of business I’m not interested in. Some people have tried to get us to start a mutual fund, and I said no there, too.

Are you still projecting $2 billion of assets in a year or so?

We could be at that in a year. We could be at a billion in three months, or in six months. It will happen when it happens. We hit $100 million in the beginning of 2009; at the beginning of 2010 it was $200 million, and at the beginning of 2011, we hit $500 million. There’s absolutely no reason why in three or four months we couldn’t be at a billion.

What percentage of that growth has come from institutional clients?

It’s been mostly institutional. Our organic business (including institutional) is growing faster than it’s ever grown. We have partners, firms who we think of as organizations, that have taken a lot of time to study our investment process and look at our people and see performance as a reflection of the process and our people. Our performance attributes are such that we offer a conservative long-term investor a proposition where we tend to capture most of the upside, and we’ve been very good at avoiding downside risk.

So all this institutional growth has been organic?

We don’t have a salesperson who’s calling these firms. Last week my chief compliance officer got a call from a multibillion-dollar firm I’d never heard of; that set up a due-diligence call with me—that’s coming up next, and then I’m flying down to meet with them next week. The week before, the same thing happened. People find us; we’re not doing anything to reach out and find them. They find us through PSN (the investment manager search and evaluation database). For three, five, seven and 10 years, and since inception, Morningstar has put a five-star rating on us.

As you’ve grown, have you had any problems accommodating these institutional clients?

We have always invested very heavily in our infrastructure and team. I have a phenomenal group of people on the operations side and we use Advent’s Moxy [Trade Order Management System], which is a powerful tool. Our capacity constraints are not with AUM or accounts; it’s with the number of custodians. We work with I don’t even know how many custodians—many, many. We’ve been telling people who are not working with one of the custodians we work with, “No.”

Every time we add another custodian it becomes exponentially more difficult for our operations side. We could go from the 1,000 accounts we’re managing to 10,000 very easily if they were already at Schwab, TD and the ones we’re already working with. If they’re spread out to different custodians it’s just difficult. The way we get around that is, we say no.

[But] in terms of scalability and capacity, in terms of dollars it’s virtually unlimited, because of the types of companies we invest in. The average market cap of the companies in our portfolio is over $80 billion. There’s no question in my mind that my team could very capably manage Berkshire Hathaway’s entire stock portfolio, and we’d do a good job. What we can’t do is work with that many more custodians. That’s the critical bottleneck.

What’s the average size of the accounts that come from your institutional partners?

Probably $450,000. The bigger we get, the bigger the accounts are starting to get. We got hired last month to manage $30 million for a hospital.

What you’re calling institutions, these are consultants or advisory firms or family offices that manage money for high-net-worth people and for foundations and endowments and pensions and unions and Indian tribes and for just all kinds of different organizations. We’ve got several university endowments now. We’re just one part of their pie.

We just have to be really careful to only take on firms that understand what we do and know what’s reasonable to expect from us. Then we have to deliver the goods and continue to be what we’ve always been.

What’s been the best part of serving institutional clients?

For me the best part is that I’m interfacing with very smart, very professional people on an ongoing basis. I really enjoy that. I’ve spent most of my career avoiding people in the financial services industry. But these people we work with right now are professionals — smart, hardworking people — and I like that.

And the most challenging part of working with institutional clients?

It’s not challenging so much, it’s just a matter of how you think of it: Our organic clients, every single one knows what we do. When I make a buy or sell decision, I’m thinking about faces, about the people.

The faces of these accounts that have come in through the different types of firms are the faces of people I know at these firms. That’s good, but I don’t know the end-clients.

What’s your advice for firms hoping to access institutional money?

If other firms wanted do this, my advice would be to put together a very, very strong investment process and spend 10 or 15 years building a great track record and building a great team around yourself. At the end of the day it really is: “If you build it, they will come.”