When managers of private funds decide to launch a strategy as a registered mutual fund–such as an interval fund, tender fund, or a daily NAV fund— the topic of custody can sometimes lead to confusion. Private fund managers are typically aware of some custody services, often bundled together with prime brokers’ services. However, custody for registered funds, typically provided by a bank custodian, is quite different in both the nature of services and fees.

Custody for registered funds

Custody requirements for registered funds are governed by the Investment Company Act of 1940, commonly known as the ’40 Act, which requires a third-party entity—a bank or a limited-purpose trust company—to safekeep investors’ assets to minimize the risk of theft or loss. This is the first and foremost purpose of a custodian.

In addition, bank custodians provide transactional processing, including facilitating trade settlement, collecting income, processing corporate actions, executing foreign exchange transactions, and providing daily cash investment options.

In the context of funds registered under the ’40 Act, fees for custody services may, in part, be based around transactional volume. The custodian processes those transactions (and assumes the operational risk), while also holding the fund’s assets in safekeeping.

In this case, a custodian manages operational risk due to the high volume of transactions processed daily. Errors in mutual fund trading, corporate action, trade settlement, foreign exchange (FX), and cash processing are potential causes of material losses. Understanding these risks along with proper controls (procedure, technology) can help mitigate these errors.

Why custody even when not required?

Alternative funds not regulated under the ‘40 Act may still wish to partner with a qualified custodian other than their prime broker depending on the needs of their portfolio or due to outside factors such as investor demand or line-of-credit requirements.

Institutional and other qualified investors may prompt a manager to ensure their assets are safeguarded. A bank custodian, like UMB, has standardized, proven processes for handling assets that can help investors to be more confident about their investment decisions.

Also, custodians have further branched out into complementary financial services, such as investment accounting, administration, tax services, foreign exchange services, treasury services and investment management. More recently, custodians have become providers of data to their clients. Using straight-through processing capabilities, a custodian can take in multiple data sources related to their customer’s investments, repackage that data, and transmit it to customers and their agents.

Bank custodians like UMB may also be able to support alternative managers even further throughout the investment lifecycle with traditional banking and escrow services, investor servicing and fund administration.

Learn how UMB can support your firm’s domestic and global custody needs with our comprehensive services and high-touch service model.