• / Free eNewsletters & Magazine
  • / My Account
Home>Alternative Investments>Alternatives Investing>The End of the 'No Advertising' Rule for Hedge Funds

Related Content

  1. Videos
  2. Articles
  1. Going Against the Grain in Hedge Fund Replication

    Ramius' Vikas Kapoor discusses some of the drawbacks of common replication strategies and how his fund strives to avoid them while still providing the liquidity often absent in regular hedge funds .

  2. How to Spot Con Men Before They Spot You

    Doug Shadel of the AARP provides a detailed outline of common scams and tactics con men use, reasons investors fall for them, and tips so that you don't become a victim of financial fraud yourself.

  3. Don't Pay Alpha Fees for Beta Performance

    Hedge fund -replicating ETFs and mutual funds can provide investors with similar return characteristics at a much lower cost, says Index IQ's Adam Patti.

  4. A Hedge Fund Approach Without the High Fees

    Bronze-rated IQ Alpha Hedge Strategy attempts to capture the tactical asset allocation of hedge funds but at a lower cost.

The End of the 'No Advertising' Rule for Hedge Funds

The battle between the SEC and hedge funds is far from over.

Terry Tian, 04/09/2012

Hedge funds have been restricted from general solicitation and advertising since Day One. Under the Securities Act of 1933, the so-called "Regulation D" states that private funds are exempted from registration with the SEC as long as they are not held out to the public. The nearly 80-year-old rule has profoundly shaped the industry. Hedge fund managers, fearing to violate the rule, often refuse to discuss their offerings or strategies in public speaking events and to the media. They even limit what they disclose to potential investors.

All of this may soon change. President Obama is expected to sign the Jumpstart Our Business Startups Act (dubbed as the JOBS Act) into law this month. A provision within the act effectively requires the SEC to lift the ban on public advertisements soliciting for private funds, provided that the purchasers remain accredited investors. Doing away with the "no advertising" rule will have significant impact on the hedge fund industry and investors in general.

Good News for Smaller Hedge Funds
The biggest beneficiary of this change in regulation is likely to be the smaller and newer hedge funds. Large and more established hedge funds typically have investors queuing up at their doors. Multibillion dollar titans easily draw attention from the media and the public, and their primary clients--institutional investors--already have relatively extensive information access to hedge funds. Smaller and emerging hedge fund managers, however, have always been struggling with asset gathering and therefore stand to reap the most benefits from the regulation change.

Lacking cost-effective ways to market their offerings, smaller and newer hedge fund managers typically rely on their personal networks, client relationships inherited from previous employers, and seed investors to raise money. Since 2008, when many of these smaller firms went bust, it has been even harder for them to attract investments from institutional investors, who are now demanding relatively high minimum assets-under- management thresholds (for example, two thirds of institutional investors require a minimum AUM of $100 million, according to Preqin ) and multiyear track records.

With the advertising ban lifted, hedge funds are now free to approach potential investors through public channels, such as newspapers, television, conferences, and websites, pending detailed rules to be established by the SEC. Even though the investor pool remains unchanged (investors must still be accredited), hedge fund managers now have the opportunity to reach potential buyers on a much broader basis than their previously limited networks. This could fuel the growth of smaller but worthy hedge funds, which may have unique investment strategies or outstanding performance track records, but are short of a well-recognized brand name or a large asset base. A larger asset base is good for both hedge fund managers and investors, as it allows the hedge fund to beef up its operational (trading, reporting, and compliance processes, for example) and investment resources (adding analysts, for example).

Improved Industry-Level Transparency and Competition
The age-old restriction on public advertising has fostered the secretive nature of the hedge fund industry today. Lifting the ban would promote public discussions and debates based on more accurate public information rather than speculations and misconceptions. (Hedge funds were blamed for starting the 2007-09 financial crisis, for example.) Widespread advertising and more publicly available information would also allow investors and third-party service providers to evaluate and compare hedge funds more efficiently, reducing due diligence costs and weeding out the weaker links.

This means, however, that the hedge fund industry is also likely to see increased competition. To win investors, hedge fund managers need to differentiate themselves on more tangible areas, such as sensible investment strategies, proven track records, and lower fees, which would all foster healthy industry trends.

Potential Risks of the Regulation Change
Even though the new legislation, the accredited investor rule remains in effect--individual investors still need to have a net worth of at least $1 million dollars excluding one's primary residence to invest in hedge funds--the potential risks of abandoning the "no advertising" rule cannot be ignored.

Terry Tian is an alternative investments analyst at Morningstar.

©2017 Morningstar Advisor. All right reserved.