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JOBS ACT to benefit investors - HF not as risky as perceived

It has been recently covered in the media that Mary Jo White, who became SEC chairman on April 10, is pushing to adopt the JOBS ACT without major changes and potentially adding additional investor protections at a later date.  While this new legislation would for the first time allow general solicitations and advertising to the US general public by hedge funds, hedge funds will still only be able to accept investments from accredited investors.

This legislation has been strongly contested by consumer advocates that remain concerned that hedge funds are risky and that unsophisticated investors might be taken advantage.  However, a quick review of the ordinary investment vehicles available to the general public and their respective risks of capital loss compared to the same risk for hedge funds would quickly reveal that hedge funds do not present the amount of risk as perceived by the general public. To the contrary, many sophisticated investors are now actually allocated to hedge funds to reduce the overall risk in their portfolio. 

Instead of focusing on hedge funds, these consumer advocates groups should be concerned that many individuals are buying: 1. 30 year treasury bonds that could sustain significant market value losses if interest rates begin to rise because of the massive budget deficits the US government is continuing to run 2. long term municipal bonds in state and local governments whose finances are in a shambles and also continue to grow their massive unfunded public pension fund liabilities 3. money market funds whose low yields are causing individuals to lose purchasing power on the money they have invested in the funds 4. and finally, individual stocks. In 2008, the MSCI world index was down over 40% which was more than double the decline of the average hedge fund. Obviously, owning an individual stock is significantly more risky than a diversified portfolio. Many companies stock price have fallen 90% to 100% in value over a short period of time, which can include such companies as Bank of America, Lehman or Merrill Lynch. There have also been many high profile frauds associated with publicly traded companies including Enron, Tyco and WorldCom. These example are given not to scare people away from investing in the capital markets, but to put things in perspective relative to hedge funds.

This new legislation will provided a number of benefits including:

Clarity of what information hedge funds can share with the general public: This new legislation will provide greater clarity to the hedge fund industry 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 organization, 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. This new legislation should bring clarity and a more level playing field to marketing strategies among hedge funds.

Greater transparency throughout the hedge fund industry: Currently it is cumbersome for investors 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.

Enhanced Investment Education for the public: 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.

More Investment Alternatives for Accredited Investors: With the increase in transparency within the hedge fund industry investors will become aware of a broad new universe of investment ideas, many of which have low correlation to traditional long only benchmarks. This broader investment universe is especially true relative to small and midsized hedge funds who have not developed strong brands in the market place.
This new regulation will cause challenges for the over worked regulators who will be responsible for protecting investors from unscrupulous marketing activity by a small percent of alternative investment firms. However, overall this new legislation should significantly benefit accredited investors by giving them more information and investment options.


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