Commissioners at the Securities and Exchange Commission have voted four to one to begin the 30 day public comment process on the Jobs Act.
This was a major step by the SEC to eliminate the ban on general solicitation and advertising for the hedge fund industry.
Agecroft Partners believes that this legislation is a fait accompli and ultimately the final regulations will end up being very favourable to the hedge fund industry, because it is good for both consumers and the hedge fund industry.
Until now, hedge funds have been banned from making general solicitations and advertising to the general public. This new legislation directs the SEC to eliminate the ban on general solicitation and advertising within 90 days; however, hedge funds will still only be able to accept investments from accredited investors. We may soon see newspaper, magazine and television advertisements from hedge fund organisations, which will have both positive and negative consequences for the hedge fund industry, institutional investors and the general public.
The hedge fund industry will benefit from this new legislation as the SEC provides greater clarity regarding how information can be provided to the public and what type of information hedge fund managers are allowed to disseminate.
To date there has been conflicting legislation regarding what information hedge funds can provide, along with wide differences in the interpretation of these regulations within the hedge fund industry. The conservative interpretation of Regulation D of the Securities Act of 1933 pertaining to the ban on general solicitation has included 1) no communication on any subject to the media, 2) no participation in databases, and 3) no contact information on a firm’s website. Yet many of these same firms are registered with the SEC and must also comply with the conflicting legislation of the Investment Advisors Act of 1940, which requires these firms to submit a Form ADV to the SEC and state securities authorities. Form ADV contains detailed information about their organisation, which is available to the general public on the SEC website, and makes it impossible to be in compliance with both legislations simultaneously.
Other hedge funds have been more liberal in interpreting these rules and believe it is appropriate to speak to the media regarding industry information excluding their firm and fund, participate in databases that are published in the media and provide some information on their website regarding their firm and investment process. The new legislation should help bring clarity and a more level playing field to marketing strategies among hedge funds.
SEC rules stemming from the Jobs Act should also benefit the hedge fund industry in reaching out to a wider audience, particularly with respect to high net worth individuals. Until now, a vast majority of direct hedge fund investments have come from institutional investors or ultra high net worth individuals. High quality small and mid-sized hedge funds should benefit from the opportunity to build stronger brands in the marketplace in order to effectively compete with their larger rivals.
Over the past three years, most net asset flows within the hedge fund industry have gone to hedge fund organisations with the strongest brands and not necessarily the highest quality fund offering. This is especially true for the hedge fund of funds industry, where many small and mid-sized funds have had a difficult time raising assets. For many high net worth individuals looking to diversify into hedge funds, a hedge fund of funds may be a more appropriate alternative due to the diversification benefits of investing in multiple managers. Agecroft expects the hedge fund of funds industry to be a major beneficiary of this new legislation.
Institutional investors will benefit from greater transparency throughout the hedge fund industry. Currently it is cumbersome to identify top quality hedge funds, compare them to top competitors in the strategy, and perform appropriate due diligence. This is because of the difference in transparency between the mutual fund and hedge fund industries.
In the mutual fund industry, a vast majority of firms provide information about their funds on their company websites and to leading industry databases. This allows investors to quickly compare mutual funds based on style and rankings in a database, and then access more detailed information about individual funds on their websites.
In the hedge fund industry, many hedge funds elect not to participate in databases. In addition, US based hedge funds have password protected websites. As a result, analyzing hedge funds has been an arduous task that includes starting with hedge fund data bases and then leveraging trade publications, industry conferences, prime brokers, third party marketers and friends to help identify top hedge funds. This is followed by contacting the hedge fund directly to obtain information about the manager, which makes it a very inefficient process.
The hedge fund industry represents a significant number of the leading investment minds in the financial industry. This new legislation will benefit the general public because hedge funds should be more inclined to share their investment views on television and in print media. As a result, retail and high net worth investors will gain valuable insights into a variety of hedge fund strategies and investment ideas.
According to Agecroft, the negative aspect of this legislation is the potential for unscrupulous marketing activity by shady hedge fund mangers who may be able to take advantage of high net worth individuals with a lower level of investment knowledge. The historical investor base of hedge funds have been institutional investors and ultra high net worth individuals who typically have a high degree of investment knowledge and use multiple evaluation factors when selecting a hedge fund. Unfortunately, some retail investors may be persuaded to invest in a fund based solely on high historical returns. The highest returning managers often are not the highest quality managers. Their historical performance might have been based on 1) a very small asset base, 2) taking significant risk, or 3) even luck. If these investors end up having an experience significantly below their expectations, it could create negative publicity for the hedge fund industry.