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Written by: RIA in a Box
In general, most new registered investment adviser (RIA) firms will need to select a custodian. The custodian is the institution that will custody or maintain the firm's client assets and securities holdings. Under the custody rule of the Investment Adviser Act of 1940 , investment advisers must generally use a “qualified custodian” or otherwise be subject to additional regulatory compliance requirements . Traditional investment advisory firms providing portfolio management services will often utilize the custody services provided by banks or broker-dealers that specialize in supporting investment advisers. The custodian selection process is a key step in starting an RIA firm as the custodian will become a vital business partner and may directly interact with the RIA firm's clients as well.
A clearing firm acting as a custodian for an RIA will generally hold client assets, process securities transactions, deduct advisory fees, and compile and deliver client account statements. When evaluating potential custodian options, the principal(s) of an advisory firm should consider the following:
Service
One of the primary motivations of operating as an independent advisory firm is the ability to serve clients in a highly customized manner. Much like many investment advisory firms view their high level of service as a differentiator, RIA firms should also carefully review the service aspects of potential custodians. The advisory firm should inquire about who they will be working with, which could be a particular person or a team. During the normal course of business, advisory firms will need to open accounts, reconcile trades, and transfer money to clients in urgent situations. Be sure to question how these types of interactions are handled from a service standpoint.
Investment Platform
Investment advisers utilize different strategies and allocation models and will need access to different markets and securities to manage their clients' investments. A custodian will provide an investment manager access to an array of investment products including equities, bonds, exchange traded funds, options and other derivatives. For firms implementing an asset allocation or diversification strategy, a custodian can provide access to a wide array of fund families and numerous mutual fund offerings. Firms not specializing in money management can utilize third party institutional money managers through the separate managed account platforms offered by custodians. In addition, some clearing firms may provide access to a range of alternative investment products.
Technology
In today’s financial services marketplace, there is an ever increasing need and reliance on technology. The plethora of technology options available to advisory firms today is leveling the playing field and allowing for independent advisory firms to compete with much larger financial institutions that often use outdated systems. RIA firms often need to manage client accounts, communicate with clients , properly bill and invoic e accounts , provide performance reporting , and build financial plans while simultaneously managing a myriad of other processes.
A custodian may often offer in-house technology or access to 3rd party providers. An RIA firm should evaluate the technology options within the particular platform they will utilize and evaluate any particular support available in selecting and properly integrating systems. In addition, the advisory firm should review its internal systems to ensure that their clearing firm can support such systems. Frequently, investment advisers underestimate the time it takes to properly select and integrate the right systems for their particular firm.
Value Added Business Support
Custodians have a thorough understanding of different types of advisory practices and the challenges that a firm can have in growing and operating their practice. In addition to hosting events, a custody firm may offer guidance on essential business goal planning, strategies to obtaining new clients, access to studies on best practices , and guidance on the proper investment adviser technology to select . By taking advantage of such value added areas of expertise, an adviser can build a more efficient and scalable practice.
Fit and Focus
There are many different advisory firms, and not all RIA custodians are the right fit for every type of practice. In addition, some traditional investment adviser custodians have minimum asset requirements for new firms. These minimums can range from $0 to over $100 million in assets under management (AUM) . Thus, while some custodians may be very willing to support smaller, emerging firms, other custodians focus on firms with well established financial practices already operating in the independent broker dealer (IBD) or wirehouse channels that are looking to transition to the independent RIA model. Thus, an investment advisory firm should define or categorize the type of firm they are and look to align with a clearing firm that best caters to them.