As hedge fund managers prepare to register themselves as investment advisors with the Securities & Exchange Commission, a number of tantalizing options for raising assets seem to beckon. Many investors who may have been wary about sinking money into a fund that operates without real government oversight may jump into hedge funds now that the products must sign up with the Washington regulators--or so many managers may dream.
Moreover, with hedge fund managers now being required to register as investment advisors, more are considering registering their funds under the 1940 Act to enable distribution to the financial advisor market and, in turn, access to their retail clients.
Hopes of tapping into new distribution channels may fade, however, when the reality of marketing and distribution sets in. Registered hedge fund totals show many funds struggling to reach the $100 million mark, proof that retail assets may be tougher to attract than the pension fund monies that are reportedly on almost every hedge fund's trajectory to stardom.
The registered hedge funds eager to move in the retail direction often are traditional firms that have sub-advisory arrangements with hedge fund managers to run the funds and distribution arrangements with their own mutual fund distributors. In some cases, though, managers must start from scratch when it comes to selling into the broker/dealer and RIA community.
It's a segment of the financial services business that still needs education on alternative investments, according to Josh Kernan, director of alternative investment services at Charles Schwab & Co. Currently 13 registered hedge funds populate Schwab's Alternative Investment Source platform. More than 100 advisors use the platform with the average purchase size hovering at $100,000. Schwab estimates that 83 hedge funds have registered under the Investment Company Act of 1940. To make it to the Schwab platform, a fund needs to be registered under the '40 Act and meet the strategic demands of the RIA community, Kernan says.
Multi-strategy funds-of-funds remain popular with advisors, but some are now branching out into single-strategy offerings. Reduced investment minimums--as low as $25,000--of some registered funds are also an attraction. "Advisors find it useful to use smaller asset amounts, so they can allocate across all accounts in a portfolio," Kernan says. Hedge fund managers must also understand that financial advisors are still new to the alternative investment world.
Despite hedge funds' forced drift into a regulatory environment, due diligence is expected to become an even more integral part of the sales process. For advisors in particular, a fund's SEC registration doesn't automatically equal an allocation.
"We had not previously assumed that registering would add or detract to what we have to do to determine if an investment is suitable for our clients," says Fred Whaley, managing director of the alternative investment group at Raymond James Financial. Whaley says the degree of transparency provided by most registered funds won't likely change right away, but when it does, it will only enhance the due diligence process.
Despite the distribution challenges confronting new registered hedge fund products, the demand for these products is the catalyst for a trend that is clearly in place: expect to see a significant increase in registered offerings on custodial platforms and at broker/dealers near you.--Susan Barreto and Jeff Joseph
Susan Barreto is a senior reporter at Hedgeworld; 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.
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