ReFlow Throws a Lifeline to Funds Seeing Red
July 29, 2002
Fund companies that are drowning in a sea of net redemptions have been thrown a new life preserver.
Sounding more like a drain cleaning company, ReFlow Management of San Francisco, an upstart investment advisory company, has developed a novel new business that essentially lends cash to funds experiencing net redemptions by purchasing shares of the beleaguered fund.
Dubbing itself a "benevolent shareholder," ReFlow purchases the shares necessary to close the gap between a fund's daily net sales and redemptions, allowing fund managers to meet excess redemption requests without having to sell portfolio securities or tap expensive credit lines. Outstanding shares are automatically redeemed on the next business day that a fund's net sales exceed redemptions. ReFlow will cap its purchases at 3% of a fund.
The concept may not appeal to giant fund companies, which often have lines of credit at banks or strong inter-fund lending programs, but ReFlow expects it will find a strong market among small- to mid-sized firms, said John McGowan, chief operating officer of ReFlow.
According to Lipper, Inc. of New York, the average equity fund now maintains a cash cushion of about 5% of assets. While numbers vary, the annual cost for a fund group to just maintain a line of credit often runs between one-tenth and one-half of one basis point, said Jeff Keil, a vice president at Lipper. "And that doesn't include the cost of actually tapping into that credit line or the elusive impact on a fund's performance," Keil said.
Oddly enough, ReFlow doesn't have a set fee that it charges fund groups for lending them cash by purchasing fund shares, McGowan said. Instead, fees are reset daily through an online auction at ReFlow's Web site in which fund companies make bids in basis points based upon the amount they want to borrow. To be fair to fund companies and minimize the impact on fees to shareholders while offering liquidity, ReFlow's Dutch auction bidding process rewards the low bidder of the day
ReFlow will make $50 million available to funds, money supplied by a family trust owned by Gordon P. Getty, founder and chairman of ReFlow and son of deceased oil tycoon J. Paul Getty. But ReFlow is already discussing ways to raise additional capital with investment bankers, McGowan said.
ReFlow was the brainchild of Getty, who a few years back noted that funds' lack of liquidity often hurt investors by forcing managers to sell securities at an inopportune time. That often created tax liabilities and pumped up transaction costs, McGowan said. Getty decided to find a way to fix that problem. More than three years after first formulating ReFlow's business model, the firm finally obtained a no-action letter from the SEC on July 15 and expects to launch in early September, McGowan said.
Not only is Getty the chairman and bankroll behind ReFlow, he is also the largest shareholder of the Forward Funds, a family of four funds based in San Francisco with $183 million in assets under management, according to Financial Research Corp. of Boston. Varied external niche money managers manage all of the groups' no-load equity funds.
The overlap between ReFlow and the Forward Funds doesn't end there. Many of the fund group's executives have signed on to run ReFlow, including J. Alan Reid, who is the president of both firms, and McGowan, who is chief operating officer of the two companies. ReFlow Management is even sharing the fund group's office space.
Not surprisingly, Forward is expected to be the very first mutual fund client to sign up for ReFlow's program, McGowan said. For each fund group that wants to participate, the group's board of directors must expressly approve participation, after considering what is in the best interest of investors. The board at Forward Funds has already had two meetings to consider the program, and approval is expected shortly, McGowan said. ReFlow is in discussions with other fund groups, he added.
As auctioneer, ReFlow is universally making its program available to all mutual funds, regardless of their size, objective, investment mandate, style or the sectors of the market in which they invest, McGowan said. However, participating funds must have a clean regulatory record, agree to waive all front- and back-end sales charges and redemption fees on shares, and be able to meet strict reporting deadlines.
ReFlow is not looking to make a profit on performance gains, but since the company is assuming all of the performance risk associated with purchasing fund shares, ReFlow will hedge potential losses using a market-neutral approach. The company has not yet named an executive to execute and supervise these hedging strategies.
ReFlow's program, however, does have its limitations. McGowan admits that ReFlow's initial $50 million kitty won't stretch very far. In addition, since it is a Dutch auction, a firm that makes a bid may end up getting shut out or lose out to another company that bids lower or requests a larger chunk of the pool.