The new JOBS Act, recently passed by Congress and signed by President Obama, is designed to make it easier for small businesses to raise capital and create new jobs in the current economy. An indirect beneficiary of this legislation is the hedge fund industry, as it will revolutionize how alternative investment managers can market their funds to the public. Until now, hedge funds have been banned from making general solicitations and advertising to the general public. This new legislation directs the Securities and Exchange Commission 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 organizations, which will have both positive and negative consequences for the 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 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. 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 firms 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. We expect 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.
The negative aspect of this legislation is the potential for unscrupulous marketing activity by shady hedge fund managers 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.
Hedge Fund Marketing Strategy
This new legislation should prompt all hedge funds to re-evaluate their marketing strategy and determine the impact it will have on their firm. Most hedge funds will initially take a ‘wait and see’ approach to observe what strategies are being utilized by other hedge funds. Some of the questions that need to be addressed include:
- What other information should be made available on the company website, including appropriate disclosures?
- Should there be different password protected areas based on what country an investor resides in?
- Should the firm develop a public relations strategy?
- Should the firm develop an advertising strategy? If so, to what target market?
- Should there be a conference strategy?
- Should the firm contact a broader universe of investors? If so, who is the target market and what is the most effective way of reaching this audience?
Not all hedge funds will modify their marketing strategy for some of the following reasons:
- Their fund is closed to new investors.
- They view their process and firm information to be proprietary and do not want competitors to have access to their information.
- They are concerned about the risk that institutional investors will perceive a reduction in brand value for hedge funds that advertise to the general public. This should be less of an issue for hedge fund of funds.
- They will not want to be distracted by retail investors, which is why many hedge funds have high minimum investments to begin with.
- They need to avoid violation of securities laws in other countries where some of their clients are based.
Where does this leave hedge fund salespeople?
Institutional-quality hedge fund salespeople will become more valuable because the majority of assets will continue to be derived from institutional investors whose decision making process is little impacted by advertising. These investors will see a significant increase in solicitations by hedge funds due to the new legislation, making them more difficult to get meetings with. Nevertheless, like the institutional long-only world, in order to increase the probability of receiving a mandate it will continue to be very important to meet with these investors face to face and clearly articulate the differential advantage a firm offers across all of the evaluation factors institutional investors use to select hedge funds.
Over the next 90 days the SEC has been directed to develop new regulations for the hedge fund industry, and once these regulations are finalized, we will begin to see many hedge funds start the process of broadening their marketing strategies. For those organizations that are bold enough to lead the charge in being the first to advertise, we expect them to enjoy a material advantage in building their brand not only through advertisements, but also the publicity generated by these ads. In order to be a first mover, these organizations need to start planning now.
Don Steinbrugge is Chairman of Agecroft Partners, a global consulting and third party marketing firm for hedge funds. He has personally met with a majority of the largest pension funds in North America and a significant number of them have been clients. Before founding Agecroft Partners he was a founding principal of Andor Capital Management, which ranked as the 2nd largest hedge fund firm in the world, Head of Institutional Sales for Merrill Lynch Investment Managers (now part of BlackRock) and Head of Institutional Sales for NationsBank (now Bank of America Capital Management).
The opinions expressed in this guest article do not necessarily reflect the opinions of eVestment or its affiliates. Nothing herein shall constitute investment advice or tax advice.