New Advertising Rules for Hedge Funds Could Benefit Asset Managers

The Securities and Exchange Commission (SEC) has proposed rules to drop the prohibition against general solicitation and general advertising by private funds, including hedge funds, in accordance with the Jumpstart Our Business Startups (JOBS) Act. The SEC is under a lot of pressure from Congress and the President to put these new rules in place. Not surprisingly, there is strong opposition from the ’40 Act regulated mutual fund industry to the rules.

But are these changes actually a threat to registered investment companies? We think not. To the contrary, fund firms that offer retail alternative investment products may benefit substantially from the public’s increased exposure to, and education about, these types of investment strategies.

The real hurdle for alternative products is lack of education. The biggest stumbling block for registered retail alternatives is not competition, but rather investors’ and some advisors’ lingering uncertainty and skepticism, borne of limited understanding, about the benefits of such products.

Our research at kasina shows that 48.3% of advisors use alternatives, but investments in this category are still relatively small, amounting to only $550 billion out of $13.5 trillion in mutual funds, exchange-traded funds (ETFs) and unit investment trust (UITs). Advisors are interested in alternatives, but they are struggling mightily with the many complexities of the products and have specifically asked for a deeper understanding of how they work.

We believe that the broad exposure and education arising from additional advertising will help overcome some of this wariness and confusion, benefiting a wide array of asset managers with registered alternatives and outcome-oriented products.

At the moment, only 29% of advisors say they believe that they have a high level of understanding of hedge fund strategies and related alts, while 60.9% want more education on these strategies. It is clear that advisors’ allocations to alternatives are related to their understanding of the products, so the new rules may well help that process along – to the benefit of the entire industry, including fund firms with ’40 Act retail alts products.

Hedge funds do not represent significant additional competition. Concerns about additional competition are certainly understandable, but we believe that the impact on registered fund companies will be smaller than feared. The onus will still be on the hedge funds to ensure that their investors are “qualified,” meaning that only individuals with at least $1 million in liquid assets, a $200,000 annual income (or $300,000 for a couple) or entities with at least $5 million in net worth can invest in hedge funds. Most of these individuals and entities are already aware of hedge funds, whether through advisors or their peers, so the new advertising may have less influence than expected.

In the end, only a fraction of investors will qualify for an unregistered hedge fund investment. But most other investors who become interested in alternatives because of the increased advertising will have to invest in a registered retail alternative product.

Ultimately, if the SEC does indeed eliminate the prohibition against the general solicitation and general advertising by hedge funds, the industry should turn it into an opportunity by employing more focused advertising and education of alternative investment products in a mutual fund format. In the end, it may help overcome the obstacles that have impeded the growth of alternatives so far.

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