From the January 2005 issue of Investment Advisor • Subscribe!

Are Hedge Funds Going "Retail"?

As hedge funds have been anointed as "hot" by virtually every financial commentator, and as coverage of them has spread from the financial media to daily newspapers, consumer finance publications, and Web sites, the notion of hedge funds descending from their perch as a rarefied product to something within reach of the retail investor has drawn much discussion and debate.

With the word out that some hedge fund products are letting in investors for as little as $25,000, the term that arises from the Securities & Exchange Commission and other interested observers is "retailization." A 2003 SEC staff report stated that "the increased number of retail investors qualifying as accredited investors raises our concern that hedge funds and broker/dealers might begin to seek out these investors as a new source of capital."

In April 2003, SEC Chairman Bill Donaldson, testifying before a U.S. Senate committee, mentioned the concept of "middle-class hedge funds" while referring to the lower investment minimums of new registered hedge funds. He then added, "But there is currently no federal requirement for a minimum investment, and it is possible that funds might seek to lower [their minimums], making these types of funds available to a greater number of individuals with even less capital." He noted that funds of funds allow smaller investors entr?e into a vehicle in which they might not normally invest because of high minimums or structural or regulatory issues with the fund.

Regardless, the meaning of retailization is relative. Within the hedge fund industry, the consensus seems to be that even if hedge funds are destined to go retail, they aren't there yet, as the majority of registered hedge fund assets are sourced via the advocacy of investment advisors and financial intermediaries to their clients, not from self-directed investments from individual investors.

Phil Duff, chairman and chief executive of FrontPoint Partners LLC in Greenwich, Connecticut (which does not manage any registered, low-minimum funds, by the way) says that while he does not perceive a tide of retailization swamping the hedge fund landscape, the traits of hedge funds that make them appealing to the wealthy will eventually bring them to more of the general public. "It will be a trend further down the road--five to 10 years," he says. "The issues that average investors have, for non-correlated returns, are as important to them as they are for corporations or institutional investors."

Craig Russell, head of sales and marketing for DB Absolute Return Strategies in New York, the hedge fund management arm of Deutsche Bank, served as a panelist at the SEC-sponsored hedge fund round table last year. "The issue at the round table was not so contentious over who should own a hedge fund. There was a comment that if these funds are so good for investors' portfolios, why are we keeping them from a portion of investors? Our view is that these make good additions to portfolios" of eligible investors, he says.

As the public continues to be enthralled by hedge funds, and as more investors of lower--but still sizeable--means continue to explore hedge funds, the products will take on more of a mainstream image. The impending regulation of hedge funds by the SEC will probably further reduce some of the mystery surrounding them. Registered funds of funds may represent the alternative investment forerunners for a new class of investor.--Jeff Joseph and Susan Barreto

Jeff Joseph is managing director of Rydex Capital Partners and serves on the advisory board of HedgeWorld (www.hedgeworld.com), a global provider of hedge fund information and investment products.

Have a hedge fund question? Contact Jeff Joseph at jjoseph@rydexfunds.com.

For further inquiries about HedgeWorld, e-mail inquiry@hedgeworld.com.

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