What Is Northern Capital?

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This is the Transition To RIA Vendor Profile Series where we take a look at the solution providers powering the RIA model. On this episode:

Vendor name:

Northern Capital

Vendor category:

Fixed Income

Episode host:

Brad Wales

Episode guest:

Steve Rye

Vendor contact info:

Website

Full Transcript:

Brad Wales – Hi, I’m Brad Wales with Transition To RIA, and this is the Transition To RIA Vendor Profile Series, where we take a look at the solution providers powering the RIA model. On today’s episode, we’re answering the question, “What is Northern Capital?” To help us with that is Steve Rye. Steve, thanks for coming on.

Steve Rye – Nice to see you. Thanks for having me.

Brad – Absolutely. So if you could tell us just at a high level and then we’ll get into the weeds, for folks that are not familiar with Northern Capital, what is that proverbial elevator pitch of what you and the team do?

Steve – Well, we are an institutional fixed-income solution. So we’re really customized and specifically advantageous to registered investment advisors.

One of the first questions people ask when they leave a wirehouse and they’re setting up their own RIA is, you know, where’s my bond desk? So, we’ll really become an extension of your investment team and help you scale your fixed income, manage your fixed income, process your fixed income, make proposals for new clients to increase your assets and help with a lot of the implementation and as much or as little as you need help in fixed income.

We have a group of portfolio managers, we have execution, we have traders, all at your disposal and the kicker is without any fees. We can get into that as we go on.

Brad – Yep. Yeah, I’ll ask you here a moment how this type of thing is priced out.

I think this is a great example for those that watch any of my episodes that talk a lot about the flexibility that comes with the RIA model and the ability to go out into the marketplace with a particular need, whether that could be for how to manage assets or some technology. You can go out and say, what all is available to me? Oftentimes there is a lot more optionality with that than being in that captive world.

You alluded to hey, where’s the bond desk? So for those folks that might be in that bigger captive environment, that bond desk could be very robust, but that was it. That was what you turned to, whether you liked it or didn’t like it for there was no other option.  So how would you help people realize what this sort of thing is? I don’t know if we want to call it an outsourced bond desk.

I am going to have my own RIA. I take it, and so please clarify this if I’m off track, that I do want to have a fixed-income part to my practice, maybe a very large part. As opposed to managing that part of it myself, I could maybe use an SMA manager, I could maybe use mutual funds or whatever, but hey, there’s a way to essentially outsource it to someone like your group if I’m correct. So is that kind of the right way to kind of clarify this?

Steve – Yeah. So we customize the solution based on the needs of the particular RIA. So there could be RIAs that have a really good handle and maybe specialize in fixed income.

We can help them primarily with things like execution, access to liquidity, things that they probably took for granted and that may be a little difficult for an institution that isn’t trading regularly in millions of dollars every day, where we are and we offer that kind of scale with the benefits associated with that.

We also, for those that may not consider it a specialty, offer the capability to customize not just individual portfolios for the clients and bonds, but strategies where there can be a consistent architecture to let’s say an investment-grade intermediate term corporate bond portfolio.

We would help define what that means and how to structure it. So we can give them not just a single portfolio, but a way for them to scale and to apply it over a number of portfolios and to manage on an ongoing basis and we’re there every step of the way helping do that.

It could even go as far as replicating most of the characteristics of a specific mutual fund that they like, except that they would then become the manager. We would be behind the scenes helping them implement it and making recommendations but they are the ultimate fiduciary and they can say no to anything. So everything is technically a recommendation. But the minute they say yes, we help implement all of it, including processing it.

Brad – So you’re an extension of the team, if that’s maybe a good way to look at it. How deep does that go? So is this high-level, we’ll help you build kind of models that you could just use with multiple clients? Is it that and then maybe all the way down to where an RIA is coming to you and saying, hey, I have this specific client with these specific needs and this amount of assets to invest in, you’re helping them with that specific scenario or how macro or micro does this get?

Steve – All of the above. It even goes down to I’m looking for the best pricing on an individual bond in the marketplace all the way up to help me define and create and manage a scalable strategy across multiple portfolios and several strategies. Municipal bonds, state-specific municipal bonds, all the way up and down the architecture.

Every step of the way we’re helping create, maintain, design, and implement on an ongoing basis. So it’s a relationship that you’ll have with a relationship manager here that will channel all the resources we have available and they will then delegate out internally to sector specialists and then deliver the solution directly to the advisor.

We don’t just make software and stick it in their lap and say good luck. We really use very sophisticated internal proprietary technologies that we’ve developed to aggregate the market so you know we’re not just distribution for what we have sitting on our shelves, for example, which is traditionally what the wirehouses would do. Or even if you’re pointing and clicking with a custodian and saying, I want this bond or that bond, you know what you’re doing. It’s just what they happen to have at that moment.

We’re more analogous to say an exchange almost where the technical term for it is called a riskless principle. That is to say, we’re almost like an exchange where a metaphor would be the difference between going to a car dealer and saying what do you have on your lot versus what is the perfect car I would want and we go find the entire country and scour everywhere and find it at wholesale dealer-to-dealer prices and then we add our markup and then that is the price for the RIA when they buy the bond, that’s it. There’s no fees.

So they’re just buying the bond from us and embedded in that is our bid offer spread that is how we’re compensated when they trade. Just like any other dealer, when you buy and sell bonds with anybody else except if you buy with us, that bid offer spread that we capture is how we’re compensated for all the services that we deliver.

Brad – That’s what I was going to say, that spread’s going to exist no matter how you access bonds in the marketplace. So the idea of using a resource like Northern Capital when you get all of this assistance in the process and there’s going to be a spread either way so you might as well get that extra value out of it.

So that might answer my next question a little bit, but for those folks that are just more familiar with, say, an SMA approach to this, and maybe the pricing is going to be a big part of this answer, but how is this different from the more typical SMA approach to managing fixed income?

Steve – So in terms of the portfolios that end up in clients’ accounts, they’re pretty similar. In terms of how it gets there is pretty distinctively unique. So when you hire an SMA manager, you’re paying them a fee, and then they’re finding the bonds, constructing portfolios, and then putting them into an account. In order to do that, typically your client has to open an account with the SMA manager, and many times they have a dedicated account for that purpose.

For us, the end clients, the advisor’s clients, never have to do anything with us. They don’t even have to know that Northern Capital exists. Their relationship is with the advisor, not with us. No accounts opening with us. Any portfolios that we prepare and help with them and construct and deliver and process for them end up in the client’s custodial account wherever that custodian is. We deal with all the major custodians.

So there’s no paperwork required from the end client for establishing any kind of relationship with Northern Capital. The RIA retains that relationship wholly with their clients. Our client is institution-to-institution only. We only deal with institutional clients, so you’ll never run into us as a competitor for your clients. I always think of mutual funds as a competitor for RIAs. Frankly, if you ask me, individual securities really are a distinctive way to differentiate yourself.

Brad – So how does that logistically work? So just to stay on the comparison to SMA, with SMA you typically open an account and then there’s some kind of a TAMP platform, if we want to call it that, that kind of facilitates the trade-in in the account. How does this work? You alluded to being with most of the major custodians. So if I’m an RIA and I open an account and I want to use your services, we’re just going to do for simplicity solely fixed income in that account. How, logistically, does this actually happen? How do the trades occur? How do the assets get where they need to be?

Steve – Sure. So we have relationships with all the major custodians, Schwab Fidelity, Pershing. We have connections, physical data connections, into these custodians such that when the advisor permits us to view custodial holdings of their groups of clients where they would like help with their bond management, and they can designate certain accounts or all of them, we then have access to reviewing those holdings and managing them, putting structure around them, making relevant recommendations. When we do transactions, we have allocation feeds directly into those custodians that will allocate them into the accounts.

So none of this is done without explicit approval by the advisor on every transaction. So a group of transactions creating a portfolio, the advisor must say yes, approved, you can execute on those.  And they can be grouped up and we have reports that delineate all the specific bonds and what their purpose is and how they perform and proposals. All they have to do is say yes, that looks good, execute and we execute at all those prices that were embedded in the reports and then they’re delivered into the client’s custodial account.

Those kinds of delivery and information coming from the custodian do not include any personally-identifiable information. So there’s no social security numbers, transmitted addresses, names of clients. It’s just the information we need to help manage the portfolios, things like CUSIPs, par amounts, things like that. We explicitly what’s called mask those fields before they even leave the custodian so that the advisor is never concerned about client information being transmitted in any way beyond their custodian.

Technically within most RIA’s form ADV they have a checkbox check that they can transmit their information to external parties, they have to do that in order to transmit the information to their custodian. So if they have a custodian it’s checked and so they’re allowed to send that information to other people and then we do it in a very secure, encrypted way with the custodians.

Brad – Just to extend out part of what you said, so this is not just build the portfolio on the front end and set it up and then you’re done. This is that, and then you use the term manage. So you guys essentially stay on top of the portfolio and review it on some sort of periodic basis or reinvest as needed when things come free up in cash, or how does that work?

Steve – Yeah, so what we’ll do is we go through a fairly exhaustive diagnostic with an advisor before we do any of this to make sure that anything we recommend is relevant and appropriate and according to what they want. So we can establish all kinds of criteria for when they want to hear from us. That can be, for example, if cash on a portfolio accumulates beyond 5% of the market value, make a recommendation that’s relevant to that specific portfolio.

It’ll happen automatically. Then when those recommendations come, they’ll get an email from us saying here’s the portfolio before, here’s the portfolio after, here’s what we recommend doing with your cash that you have, the exact bond, the exact price, would you like to do it? All they have to do is say yes, and it happens, and it’s all processed.

Then on an ongoing basis, we’ll take direction from the advisor on what they’d like to do ongoing so we’ll have thresholds if credit ratings drop on an individual holding that client has below a certain amount or by certain increments. Let me know and I’ll tell you what I want to do or recommend what to do.

Or if a client’s portfolio starts to age and get closer to maturity, do you want me to regularly rebalance so it retains its characteristics? We can do that and we make recommendations on an ongoing basis. If you want to periodically rebalance the portfolio, we can say, okay, how frequently and how much turnover is too much and how much is too little. Everything is geared towards what the advisor would like to see.

We can even do things that you can’t do with most individual bond management because it’s in theory very simple, but in practice it’s very difficult. I can tax loss harvest for example. They can say any losses I have in bonds, I want to realize tax losses and be reinvested into securities that would not conflict with the tax rules around us doing so. We can do all that in scalable, automated ways and all with the advisor’s direction and approval.

Brad – So with that level of support, where does this start to make sense size-wise, and I’ll let you define what that is. I don’t know, and I assume you kind of have minimums because a partnership’s got to work on your side as well. Is that defined by likely investable assets? Is that defined by the overall size of the RIA? Is that defined by the number of clients or where do you see this, well one, where does it need to be for your sake and then where do you see as kind of your sweet spot of size practice where this really is a good fit?

Steve – So, first of all, there are no hard delineations. But in terms of a rough sort of estimate of what’s on the smaller side you know, maybe 30 to 50 million in fixed income, somewhere around that part, that kind of area, or maybe even less. It really just depends on the needs and whether it can be mutually beneficial. We could decide on a case-by-case basis, but generally speaking, it would be beneficial for both us and the advisor if fixed income is somewhere in the 30 million or above range, especially for those just starting out and leaving a wirehouse.

You know that being said we have institutional clients that are in the many billions and we have a lot in the 30 to 50 and we have 100, 200, we have across the spectrum and frankly our service is pretty darn similar across the board. So there’s no real difference in scope because everything we do is very scalable.

So it’s not like we need a minimum to make it worth our while because we have a very scalable way of doing this in a way that’s also very customized and attended to.

So in terms of individual portfolios, it’s really a function of the minimum number of bonds that you need to be able to achieve your goals. What I mean by that is if one of your goals is diversification across industry sectors in corporate bonds, well, you’d need 10 bonds to do that to get across all the different industry sectors. And, you know, a smallish lot would be 10,000. So let’s call it, you know, somewhere around 100 to 200,000 would be the minimum size of a portfolio just to achieve what your goals are. That’s really what drives minimum size for individual portfolios, achieving the client’s goals.

Brad – How does it, for folks that this does resonate with, they’re probably doing something currently, right? I guess your job would be easier if everyone showed up and all the investable assets are in cash currently and it’s just looking forward, right? But they’re likely either coming from maybe they were doing it themselves, the advisor, and realize that for all kinds of reasons it may be better to outsource it to you, or they were using an SMA manager. They’re wanting to step back from that and maybe they’ve kind of de-linked the manager, but the assets are still sitting there.

So I assume, whether we want to call it the conversion or the on-ramp or whatever term we want to use, that that’s part of what you do is look at, okay, no matter what it is currently, we’re going to try to manage into that situation and obviously be tax-sensitive and things like that. Is that accurate to say?

Steve – Yeah, so that’s a good point because a lot of SMA managers, the first thing they want to do is just wipe the slate clean and sell everything at whatever price they can get and start fresh. That’s not the best thing for the client, frankly, because they’ll end up just eating a lot of whatever the bid is for a given bond at that particular moment. It could not be the optimal time to sell that particular bond, that kind of thing.

So what we do is, we’ll do what an advisor wants, but if they ask for a recommendation, we’d say, well, let’s just ease into it. Let’s take what you have and over time it becomes what you want it to be, and we’ll give you a path to get there without just having to start fresh. We find that most advisors come in with some fixed income already.

So the idea was that’s a common thing to sort of get there over time. What we find is when advisors are just starting out, it may not be that hard to keep an eye on a few dozen portfolios and maybe point and click with the custodian if you’re lucky enough to find the bond you want and that kind of thing.

But if you’re ever going to consider growing and scaling, you’re going to spend all your time doing that so our feedback from the advisors that we’ve seen growing the fastest is their time is most valuable in interacting with their clients and growing their assets.

With the fixed-income portfolios, what I think are a very important part of the asset pie is just one slice because the nature of the instruments can be kind of time-heavy on processing and operationally handling them and allocating and finding bonds. This can really eat up a lot of your time for maybe a smaller amount of benefit relative to all the benefits you’re bringing to a client. That to me screams outsource.

Brad – Which just reiterates what I said at the top that obviously I’m biased towards the RIA model, but the RIA model allows you to go out in the marketplace and say, is there a better way to do this?

I would encourage advisors and teams that have maybe only been at one firm or one kind of channel their whole career, that that is a way to do it, but that’s very likely not the only way to do it. That’s just maybe all that’s been available to you, and who knows, you might choose to continue on with something similar going forward. But there are solutions like this that you might want to consider as well.

I know we’ve just been kind of at a high level here, but for folks that would like to learn more about how this might work for their particular practice 1) if you could, what’s the best way for folks to get a hold of your team and then 2) when someone does perhaps reach out, what does that first conversation typically look like?

Steve – Sure. So there’s one thing I just wanted to mention before I get to that. A very important distinction between us and frankly any dealer I can think of is our approach to objectivity and how we look at transparency.

So everything we do, we fully disclose in a report, in the monthly, quarterly, every single trade we do with a client and what we made on it. We negotiate that in advance, a grid of what our compensation is going to be. No surprises. It eliminates any bias we may have to give you one bond versus another.

Another important thing is objectivity, where we have no incentive to put you into any kind of portfolio, more risky, less risky, because we don’t get any kind of different compensation. So I think those are important things. I just didn’t want to leave without mentioning them.

In terms of how to reach us, our website is northerncapital.com and then our email invest@northerncapital.com. We will hook you up immediately with a relationship manager who will go through and learn about your business and what your needs are, explain very carefully and in-depth how we could help and what we do and how we do it and sample reports and all kinds of things. But that’s the easiest way to get to us quickly and have somebody call you right away.

Brad – Perfect. So to repeat that, northerncapital.com. The email is invest@northerncapital.com. We’ll put that in the show notes as well. Steve, I really appreciate you coming on and helping us understand more about what is Northern Capital.

Steve – Thanks and I love your videos. I really think advisors benefit from that. I’m glad I’m a part of it.

Brad – I appreciate the kind words and I appreciate you being part of it as well. So thanks, Steve.

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