Hedge funds are soon to get their own fair shake at telling their own story.
For decades, the industry had to hide itself. Laws prevented the industry from touting its success, and explaining its failures. Hedge funds, which can accept capital only from accredited investors who earn more than $200,000 per year or who have a net worth of $1 million or more, couldn’t legally advertise to the public.
That’s all changing – and I think it’s awesome.
What Hedge Funds Aren’t
Hedge funds have a certain allure to them. Hidden from the public, many think that hedge funds involve themselves in somewhat “shady” corners of the market. Hedge fund managers are bullied as the worst of the world’s capitalists, greedy investors who would do anything to make a buck.
Hedge funds are not all that different from mutual funds that the ordinary investor might hold in their retirement portfolios.
In fact, there isn’t much to separate an actively-managed exchange-traded fund from a hedge fund. Hedge funds are just quasi-holding companies, often formed as an LLC or LLP in which investors can purchase shares. After raising capital, hedge funds go to work deploying assets in the financial markets for the ideal – a market-beating return.
Sure, hedge funds can short the market unlike long-only mutual funds. And hedge funds do not have the typical diversification requirements of mutual funds. And some are high fee – the industry standard is 2% per year plus 20% of gains above a “high water mark.” If a high water mark is set at 8% per year, the manager takes 20% of all returns in excess of 8% annually.
This is Awesome
As someone with an interest in opening my own hedge fund in the form of an early Buffett partnership for friends and family, I’m elated with the changes in advertising laws. (Buffett’s first partnership promised a positive return, and charged fees only when it beat its 8% annual return requirement. Buffett only missed that mark once.)
Hedge funds should have the same opportunity as any other company to build their brand. The next step is to remove entirely the requirement that investors are accredited. I see no reason why the rich should have access to fairly compensated hedge fund managers while the middle class should be left to invest only in mutual funds where the manager has very little incentive to outperform.
Government is slow to change, though. For all you entreprenuers interested in launching your own fund, check out this post at FWallStreet to see just how easily you can set up your own hedge fund. The hardest part was always advertising – that barrier will disappear when the SEC makes its final vote later this year.