Custodial services for alternatives require hands-on approach

Fed up with the recent volatility in publicly traded stocks and mutual funds, some sophisticated investors are looking to alternative investments for portfolio diversity and enhanced returns.

These alternative investments might include offshore funds, private stocks, private corporate debt, limited partnerships, limited liability companies and real estate. Some risk-tolerant investors also see plunging real estate prices as an opportunity to invest in real property, directly or through real estate LPs, LLCs or real estate investment trusts.

For investors and financial professionals considering alternative investments, one key decision is, “Which custodian do I use?”

To answer this question, investors probably will need to look past the typical names that come to mind. Recently, The Charles Schwab Corp. of San Francisco said that it will no longer accept additional purchases of any form of alternative assets for custody after April 30.

Large-volume broker-dealers such as Schwab, Fidelity Investments, Pershing LLC and TD Ameritrade Holding Corp. have systems and service models in place designed to fit the traditional investor, and this is where they excel. They work primarily with publicly traded investments and typically hold alternative assets only for high-net-worth clients as an accommodation.

Companies that provide custodial services for accounts holding alternative investments, however, should have knowledgeable and experienced professionals familiar with the nuances of administering these types of accounts. They also should have systems and operational processes specifically designed to address the complexities inherent in administering accounts that hold alternative investments.

These custodians should be able to hold traditional investments as well.

Providing custodial services for accounts holding alternative investments requires much more of a hands-on approach than is needed for accounts that just invest in stocks and mutual funds.

Choosing a custodian whose staff, systems and processes have been designed with alternative investments in mind means working with a company whose entire business model caters to these types of investments. Asking the right questions of potential custodians will help you make the best choice. Here are several questions to consider.

• Why do I need a custodian that focuses on alternative assets?

Unlike custodians that specialize in alternative assets, custodians that focus on high-volume transactions aren’t set up to handle such issues as administrative reviews, communicating with investment sponsors, working with closing agents or title companies, or soliciting asset sponsors for updated values.

That means that it often takes “standard” custodians longer to complete the hands-on administrative processes inherent in dealing with alternative investments. Managing these processes simply isn’t what brokerage firms do best.

For example, if an investor purchases a single-family home as an investment in his retirement plan, the custodian might review the closing statement, owner’s title report, purchase agreement and the escrow instructions, to name just a few of the documents.

Working with an experienced staff is essential when it comes to funding and holding alternative investments. You don’t want to work with a company that does it just as a sideline or an accommodation.

As in the case of the client investing in real estate, ask if the custodian communicates directly with the asset sponsor, real estate agent, mortgage company or closing agent to complete the transaction.

• What type of reporting detail is offered?

Look for a custodian with systems designed to accommodate transactions related to the product, such as a trust accounting platform. Depending on the investment, this might include principal and interest, note payments, rental income and maintenance expenses.

• What kind of service can I expect?

Personal service provided by your custodian is crucial to keeping and maintaining a long-term relationship. With that single-family home investment, for example, you want to work with a team of customer service representatives who understand and can explain the complex requirements of administering these accounts.

The requirements vary depending on the assets held.

• Does the custodian use technology to help investment professionals help their clients?

The custodian’s trading support services platform and other technology should match the needs of investment professionals and be easy to use. The platform should also offer the ability to download transactions and balance information pertaining to alternative investments.

Again, a platform based on a trust accounting system will provide important information, quickly and efficiently.

• How does the custodian operate as a business?

Ask how long the custodian’s staff has been servicing alternative investments. Is being a custodian the company’s only business, or does the custodian also offer investment advice or proprietary products?

You should look for a custodian whose core business is administering accounts that hold alternative investments.

Make sure that the company is insured and regulated, and that internal and external audit processes are in place. Is the company financially stable and willing to show its financials to you?

Also ask about its disaster recovery plan. What safeguards does it take to protect the personal account information of you and your clients?

How does it protect funds being transmitted between banks? Does it hold a designation (Tier III is best) under the standards of the Uptime Institute of Santa Fe, N.M., for reliability and stability?

Are the premises kept secure with surveillance cameras, key card access and entry codes? Is the equipment monitored 24/7 by multiple operation centers?

Alternative investments aren’t for everyone, but for sophisticated investors interested in private placements, promissory notes, offshore funds, or residential or commercial real estate, whether it is via an alternative investment vehicle or the purchase of real property, the best bet is to work with a custodian that knows what it is doing.

Sean Gultig is a vice president at Trust Industrial Bank, also known as Fiserv Investment Support Services, which is based in Denver.