An Emerging School of Thought: "Let the Middle Cla

WASHINGTON (HedgeWorld.com)--Paul Roye may have given new momentum to a bandwagon when he told the Investment Company Institute's annual gathering that current restrictions on mutual funds may unnecessarily constrain managers, prohibiting their use of some of the strategies associated with hedge funds.

Mr. Roye, director of the division of investment management for the Securities and Exchange Commission, made the usual disclaimer at the start of his May 23 presentation: his views are his own and not necessarily those of the SEC, its members or of his colleagues on the staff.

Furthermore, his remarks came only near the end of an address devoted chiefly to the ways in which he believes mutual funds ought to be "proactive" in regulating their own industry, through compliance programs and by monitoring conflicts of interests.

In addition to such self-regulation, Mr. Roye said, "the industry should be asking whether there are better ways to meet the investment needs of its shareholders. The division staff is also considering whether there may be benefits to expanding the kind of investment strategies that are offered to mutual fund investors (to include) certain market neutral strategies, which typically have been the province of hedge funds. As we all know, investors with a substantial portion of their portfolios in long equity funds have had a rough ride during the past three years."

Despite the disclaimer and the apparent casualness of these words, Mr. Roye's comments will draw attention coming as they did so soon after the May 14 and May 15 SEC roundtable on hedge funds . Chris Wloszczyna, a spokesman for the ICI, said that although the institute would be interested to learn of any more specific ideas, "we'd have to express caution about any changes to investor protection regulations that are in place." Some observers have expressed disappointment that no unifying theme came out of the roundtable's many discussions and perspective. Perhaps now a theme is developing retrospectively.

Mr. Roye's comments came only one day after William H. Donaldson, chairman of the SEC, made a formal presentation to a subcommittee of the House of Representatives on the roundtable and the broader investigation of which it was a stage, Previous HedgeWorld Story. Mr. Donaldson only briefly mentioned the possibility of any change in mutual funds rules. But the capital markets subcommittee of the Financial Services Committee, chaired by Rep. Richard Baker (R-La.) also heard that day from John Mauldin, president Millennium Wave Investments LLC, Fort Worth, Texas. Discontent with a two-class structure, in which mutual funds cater to the middle class and hedge funds with a broader range of strategies cater to the wealthy, was the motif of Mr. Mauldin's presentation.

Mr. Mauldin has since elaborated on his case. "I don't think the SEC will (abandon this two-class structure)," he said in an interview, "I think Congress might," but the SEC itself is in the meantime limited by its statutory mandates. The best way to go about bringing hedge fund strategies to the middle class, though, would not be (in Mr. Mauldin's view) by loosening of the rules on mutual funds. Many investors in fact want long-only funds, and the existing structures should remain in place to cater to them. For those who don't, though, there should be a hybrid structure available, which he calls a "Hedge Fund Investment Company."

"I don't think this is a popular position," Mr. Mauldin said. "If you are a large successful hedge fund, this is exactly what you don't want," because you are successful within the status quo. Likewise, the ICI favors the bifurcation of the market because its members are likewise successful in that context, but they may be "rethinking their negative position."

Mr. Mauldin said that after his presentation to Rep. Baker's subcommittee, a lively exchange took place in which he was "really quite surprised" at the interest in and the openness to his idea shown by the members. "They showed an interest in and an understanding of the markets" that he found refreshing."

CFaille@HedgeWorld.com

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