The JOBS ACT – Why The Hedge Funds Are Not Marketing
By Ronen Schwartzman – Founder, Ten Capital Advisors
On September 23, 2013 a key provision of the JOBS Act was finally approved by the SEC and for the first time it allowed hedge funds to market themselves directly to accredited investors. In theory, this is a great opportunity for these money managers to better communicate with the public and, to some extent, remove the "black box" cloud that lies above the hedge fund industry. By providing more transparency, the industry as a whole should benefit as some of the unknown will be lifted. This should lead to more and more investors feeling comfortable with hedge funds and investing in various strategies with different managers. Since we are used to seeing advertisements from the mutual fund industry (money management business) for many years, some thought that investors would be inundated with advertisements from hedge funds as soon as the JOBS Act was approved. However, it seems that hedge fund managers are taking baby steps in taking advantage of the ban removal and start marketing themselves to the public. In my point of view there are a few reasons why we have yet to see a meaningful marketing blitzkrieg by the hedge funds:
1. Regulatory requirements: SEC versus CFTC. The lifting of the advertising ban was approved by the SEC and allows hedge fund managers to market; however not all the hedge funds are long / short equity managers that are regulated by the SEC. Other strategies that are used by hedge funds include: structured credit, distressed and long / short credit as well as event driven, global macro and commodity trading. These hedge funds may be regulated by BOTH the SEC and the CFTC and, as such, it is still not clear for them if they are allowed to market. Chief compliance officers in these firms may be hesitant to approve any marketing effort that may be considered a regulatory risk for the firm. Furthermore, the SEC has proposed rules to amendments to Regulation D, Form D and Rule 156 (relating to investment company sales literature). The proposed rules would impose additional filing and disclosure requirements on issuers using general solicitation and advertising in Rule 506 offerings – all of which create another deterrent from advertising. Ron S. Geffner, Partner and Head of Financial Services at Sadis & Goldberg LLP adds "We anticipate that various regulators will interpret the final rules as narrowly as possible to provide for the maximum protection for investors. Moreover, the final rules could conflict with other regulatory regimes, such as the Commodity Exchange Act and various state laws. Additionally, in connection with the JOBS Act, alternative investment fund managers have expressed concern that if they elect to advertise, they may receive unwanted regulatory scrutiny." All of the above might have the hedge fund managers to stay on the sidelines and wait for more clarity regarding the law.
2. Adverse selection: Unlike mutual funds and long only managers some hedge funds have a limited capacity (a long / short equity manager that invests in small cap stocks for example) and do not necessarily wish to raise an infinite amount of assets but rather close their funds to new investors once they reach a certain capacity, whether it may be $500MM or $10BN, which fits the limits of their trading strategy. In fact, and this is one of the biggest problems when searching for managers to invest in, the real high quality and proven hedge fund managers do close their fund to new assets and sometimes it can take years before they re-open their funds to new investors. Since these funds are in full capacity and, in many cases, have more demand from investors, either existing or new, they simply don’t have the need to market in order to raise new assets and can continue to operate without the publicity and the headline risk.
3. History of fraud in the hedge fund industry. In the last few years we witnessed several cases of fraud in the hedge fund industry. The spectrum of fraud is large and begins with cases like Madoff and Stanford that were Ponzi schemes where investors lost all their money to cases like Galleon, Level Global and SAC that involved insider trading which resulted in fund wind downs and dissolutions. Whatever case of fraud it may be there is a similar headline risk effect that is hurting the overall hedge fund industry. One of the outcomes has been more focus on the importance of initial due diligence when selecting an investment manager. No longer is "golf course" investing or allocating to a hedge fund manager just because a friend told you about it acceptable. Instead, a more prolonged, detailed and proper due diligence check on both the investment and the operational side of the hedge fund takes place before investing. Hedge fund managers are aware of this and may question the value of mass emailing or marketing to a crowd of potential investors knowing these people will go to their advisors before making any investment decisions.
4. Cost: Hedge funds can choose from a variety of options if they wish to market. They can place ads on TV, in magazines, newspapers or utilize social media and develop a comprehensive website. Each of these options is unique and has a different price tag, as well as time and effort dedicated to maintain it. If you are a small and emerging hedge fund manager with a limited amount of assets you most likely also have a limited amount in your budget that could be directed towards placing an ad. Attending a conference would be a much less expensive way to meet potential investors.
5. Unproven ROI: In any investment decision in a business the CEO wants to know what will be his return on that investment prior to approving the expense related to that investment. Like any other new "product" that has a limited amount of data it has yet to be proven what is the return on investment relating to advertising of hedge funds. The key question facing the hedge fund manager is "Will spending money on advertising help me find new investors and grow my business"? Since these are the first months of this new era, the amount of data is still limited and the concept is yet unproven which may halt different marketing decisions within the hedge funds.
6. How to start or figuring out the best way to reach your potential investor: Hedge funds have much higher minimums to invest than mutual funds (they usually start at $500K in small funds and can be as high as $5MM) and, for the most part, only accredited investors are allowed to invest in them. Moreover, institutional investors such as pension funds and endowments are using consultants to recommend hedge fund managers. Hedge funds, therefore, should consider marketing directly to these advisors instead of or in addition to the end investor. But, these consultants are investment professionals that spend most of their time evaluating different hedge fund managers and probably already know or heard of most of these managers. Therefore, finding the best ways to target your potential investors is the key question.
To answer this question and how to think about starting a marketing campaign, April Rudin, CEO and founder of The Rudin Group, a wealth management firm, and chairperson of the High Net Worth Advisory Board of the Hedge Fund Association, says: "The best advice is to create a marketing plan. HF's need to understand that marketing consists of utilizing specific messages, targeting different audiences within the accredited investor universe like retirees, entrepreneurs, other financial services professionals, actors/athletes, etc. No HF manager would make investments without a planned strategy and the same apply for marketing-create a planned strategy."
Similar advice comes from Elijah Duckworth-Schachter, a director of financial advisory at Point One Percent: "Fund managers all too often view marketing materials as an afterthought. This is a mistake; marketing materials are one of the few things completely under their control to differentiate themselves when raising capital. The most important thing a fund can do is ensure that all communications are crisp, clear and concise. LP's must understand the investment strategy, returns and how the firm is differentiated easily and quickly. This should extend across all investor touch points from website to marketing presentations and quarterly letters. Remember, a potential LP may read the power point presentation a week after the initial meeting, he/she has to be able to understand and explain it to colleagues quickly without the PM in the room."
Time will tell if the JOBS act changed the nature of marketing and communications of the hedge fund industry. However it is important to remember that no matter how an investor gets to learn about a hedge fund manager, whether be at a conference, direct email, a newspaper advertisement or a fancy web site, conducting a proper due diligence, both on the investment side and the operation side of the business, is a must prior to making any investment decisions in hedge funds.
About Ten Capital Advisors
Ten Capital Advisors is an independent New York based hedge fund advisory company focused on providing customized solutions to its clients regarding their investments in hedge funds.