Surprise! Not Every Hedgie Loves the Lifted Ad Ban

‘If an investor has a bad experience with an investment, it could be bad for the industry,’ says IndexIQ CEO Adam Patti

When the Securities and Exchange Commission lifted the ban on hedge fund advertising last week, many in the industry applauded the move, saying it was high time that hedge funds and private equity firms got a level playing field against the competition in terms of marketing themselves.

"The lift on the 80-year-old ban that prevented entrepreneurs from advertising their efforts to raise equity is a huge step forward,” said Joanna Schwartz, CEO of the crowdfunding platform EarlyShares.com, in a highly optimistic statement about the future for hedgies and venture capitalists. “Economic growth is driven by small business and enterprising individuals who follow their passions, and that requires capital. This ruling eliminates a big friction point in the capital-raising process."

Clearly, there are those who loved the lifted ban. Yet some in the hedge fund industry believe that marketing isn’t necessary for these sophisticated investments, and others worry that fraud may be an unintended consequence. Surprisingly, some are plainly against the congressionally mandated rule required by the Jumpstart Our Business Startups (JOBS) Act that allows issuers to use previously unavailable solicitation and ad methods to find new investors.

Adam Patti, CEO of IndexIQ, which sells exchange traded funds that replicate hedge funds, opposes the lifted ad ban because it may ultimately do harm to what until now has been a closed market for sophisticated investors.

“I believe that it could be harmful not only to investors but the industry if there is not a proper amount of education provided to investors who will be seeing all these ads for vehicles they probably shouldn’t be invested in,” Patti said in a phone interview. “If an investor has a bad experience with an investment, it could be bad for the industry. The lawyers are probably circling already to pounce on the first thing that creates problems.”

‘The Advisor Should Educate the Investor’

Patti then pointed to the hypothetical example of the billionaire hedge fund manager John Paulson, whose gold fund plummeted 65% through June.

“Paulson’s fund has had a horrible performance this year,” Patti said. “What about that little old lady watching the Today show with $1 million to invest, and she sees an ad for the Paulson fund, and calls her advisor saying she wants to invest in that fund that she saw on TV? An investor may technically have access to that fund, become more interested, go to their advisor and start clamoring for the fund without knowing the risks. Certainly, the advisor should educate the investor.”

On the plus side, BackTrack Reports founder Randy Shain, whose investigative firm provides due diligence background reports on some 7,000 hedge funds, said he was thrilled with the lifted ad ban.

“I’m all for information being public,” said the self-described libertarian in a phone interview. “I’ve always thought this ban was unrealistic. It doesn’t speak to the way that business gets done. When someone thinks of investing in a business, you don’t say, ‘I can’t tell you about it.’ The removal of the ban is a welcome change.”

Don’t Look for Ads at Bus Stops

Shain acknowledged that the ban was intended to protect retail investors from unscrupulous companies. Yet only accredited investors with a net worth of at least $1 million or who earn a minimum of $200,000 are permitted to invest in these offerings, he said.

“Big hedge funds are very unlikely to market to the average individual and post signs at bus stops,” Shain said. “It’s in their interest to market to institutional investors. If you as an individual investor don’t have the money to do due diligence on a hedge fund, then you don’t have the money to invest. You’re either all-in or you’re not. Think about the due diligence people do when they buy a $1 million house.”

As people in the hedge fund industry watch to see whether any unintended consequences, such as fraud, result from the lifted ban, Bloomberg predicts that many funds will feel pressure to promote themselves as competitors take advantage of their new freedom to advertise. For example, write Dave Michaels and Margaret Collins for Bloomberg, “some may experiment with low-cost venues such as social media while others may sponsor sporting events that attract wealthy investors.”

Ultimately, however, many sophisticated investors who are drawn to advertised hedge funds may decide to avoid them. As Pragmatic Capitalism blogger Cullen Roche points out in “So Much for Non-Correlation in Hedge Funds,” recent data show not only “abysmal performance,” but increasing mutual fund-like characteristics in many hedge funds.

“I hate to be so general about this when there are clearly some funds that are probably worth owning for various reasons, but it’s kind of amazing that the 2 & 20 fee structure has lasted this long,” Roche writes. “At this rate the fee structure of the hedge fund industry is beginning to look a lot like a legalized scam.  And now that scam is going to be sold to every mom and pop in the mainstream media when hedge funds unleash their vast coffers.”

Read SEC Lifts Ban on Hedge Fund Advertising at ThinkAdvisor.

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