How To Think About Building a Spoke Fund®

Below are some thoughts for new portfolio managers to consider before building a Spoke Fund®.  I’ll elaborate more on these ideas and others every week.

A Caveat

When it comes to building a Spoke, I am assuming you already have the magic rocks necessary to be a good portfolio manager. It entails some hefty responsibilities, including a fiduciary duty. There is also a huge difference between being a good portfolio manager and running a business that is good at portfolio management. I’ll be focused on the latter here.

Learn From My Mistakes

I’m a value investor. Among other things, that means I can be pretty stingy. I’m so cheap that I once drilled a hole in a nickel so I wouldn’t have to pay six cents for a washer. My car is so old that I keep losing my wife on left turns. And when it came to starting my firm and my Spoke Funds, I instinctively took a do-it-myself approach, simply to save cash. At times, however, that approach ended up costing me more.

In an effort to spare you that trouble, I will be recommending you outsource certain tasks on day one. If another expert can do a project better and cheaper than you can, offload it. You’ll be extremely busy the first few months. The tasks you should outsource may not be the same as the ones I recommend, however. To be able to decide what to keep on your plate and what you should hand off, you’ll need to figure out your effective hourly rate.

The Outsourcing Number

I guesstimated my time during start-up mode was worth $27 an hour. How? Finger in the air, really. I knew Warren Buffett’s annual salary was $100,000 a year and decided that it was bad juju to assume I should be paid more than The Oracle. I also figured there wouldn’t be any vacations that first year and that I’d be working 70 hours a week. So:

$100,000 / 52 weeks / 70 hours a week = $27 an hour

There’s a little more to the actual formula, but I ignored self-employment tax. And to be clear – your fees as a spoke fund manager are based on assets, not hours, so consider that number a hurdle, not a measure of value added. In the end, the rate itself will be less important than having a rule of thumb for deciding what to outsource and a hyper-awareness of opportunity costs.

Using that rate, I could then tell the cost to the company if it took me ten hours to format our monthly newsletter – at least $270. If Gecko Graphics can do the same job in six hours for $25 per hour, I’d effectively save $120 by outsourcing it. Even more valuable, however, is that I’ve saved myself time I can then spend working on more important projects.

Simple concept, but a powerful one. I’m hopeful that if nothing else this blog can help reduce your hours per week as you launch your spoke fund. If we can get you down to 40 hours per week, your effective hourly rate will be $48 in the above and you’d save that much more time and money by selectively outsourcing.

Were I an investment banker, I do believe that would also mean I would then have created $21 of value per hour for you, right out of thin air. Paypal accepted.

Last Chance to Back Out

As I mentioned here, I choose to start a Spoke Fund® versus a mutual fund and/or hedge fund after considering each option for some time. If you want more info on how to start a mutual fund, the best guide I found was Melinda Gerber’s first book. If you want to start a hedge fund, I’d highly recommend you see Joe Ponzio’s recent summary on FWallStreet.

Now, on to some initial thoughts.
 
How to Think About Building a Spoke Fund®:

1 – Destroy the dream.  Many new portfolio managers dream that putting up great numbers is all it takes to bring investors to the doorstep in droves. Banish the thought. You need to love the business more than the dream if you’re going to make it work. 
 
2 – Think like a billionaire, work like an immigrant. Launching a spoke fund means building a firm, not just picking stocks. When it comes to the business, focus on process and systems. When selecting stocks for your fund, work like Rocky in that barn in Russia.
 
3 – Get comfy in the long tail. Starting a Spoke Fund® means you’re a volunteer outlier. There simply aren’t many around yet. You’ll get no shortage of questions, and some folks may throw darts at your newfangled model. Ignore them. Your clients are all that matters.
 
4 – Find a brain trust. If you’re lucky enough to have a mentor, latch on like a tick in the tall grass. Otherwise, consider finding a business coach or putting together an informal advisory board. You’ll need those other voices in your ear as well as the occasional kick in your pants. Emphasize sales and marketing experience when choosing your advisers above all else.
 
5 – Plan like it was D-Day. Fund yourself. Have enough money in the bank to survive a nuclear winter before you start. Think about what you’ll sacrifice to make the business work. And though I think it probably goes without saying for this crowd – focus first on cash flow, then profitability.

6 – Obsess about the critical path. To launch your Spoke Fund® as quickly and as smoothly as possible, you’ll have to juggle many tasks in parallel. I’ll give you my thoughts on the sequence of tasks that determines the shortest possible time to get you to launch.

7 – Become a registered investment adviser. No cute headlines here. Being a fiduciary is unlike any other role on Wall Street. It’s also essential to the Spoke Fund® model. I’ll post more on how to accelerate this process soon (hint: we’re going to outsource it), along with some thoughts on NAPFA.
 
8 – Master the Folio platform. Three things are essential to the mechanics of Spoke Funds from the manager’s perspective: basket trading, one click syncing and cost control. FolioFN is light years ahead of everyone else. We’ll spend a lot of time going over the Folio back-end.

9 – Stay lean. Technology will be another huge help in keeping your costs low and productivity high. I’ll tell you more about every tool I can think of when we get to this point – from desktop software to electronic signatures to CRM tools.

10 – Think local. As an analyst, I used to think the power of local economies of scale were among the most underrated advantages in business. As the owner of a small business, I’m now convinced they’re even more valuable.

11 – Your weakness is better than their weakness. Sales and marketing will be by far your biggest challenge when it comes to growing any fund. That represents an opportunity for the Spoke Fund manager, though, for three reasons. First, unlike a hedge fund, you can advertise your Spoke Fund®. Second, your business will have a ridiculously low breakeven point compared to the average mutual fund company – which means you can successfully market directly to investors in places where mutual funds won’t go. Finally, while brokers and mutual fund companies are good at filling investor demand, you, my friend, can create it – assuming you’ve got those magic rocks.

12 – Yours is a superior product. I believe the features of Spoke Funds are unequivocally superior for investors when compared to both mutual funds and hedge funds. All things being equal, it’s far easier to market a remarkable product like a Spoke Fund® then to put whipped cream on the cow chip that is yet another mutual fund. And now more than ever, people are exhausted from having being fed so many cow chips by Wall Street. So your timing and product couldn’t be better.

My next post in this series will identify the critical path activities that I think most deserve your initial attention.

And if you decide to start a Spoke Fund®, please let me know in the comments section, this form or via email. I’ll plug you and your firm here on CaleInTheKeys, help you as best I can on Twitter, and eventually highlight all new spoke managers on SpokeFund.com.

For now, let’s get ready to go to work.

Portfolio managers: go to www.SpokeFund.com for more about how to build a spoke fund.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.
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