A decade ago, two business school graduates founded a hedge fund with a $15 million portfolio, with seed money from family and friends. A top Wall Street hedge fund manager investor gave them desks and back office support. The young managers invested in complex, under-the-radar opportunities over the next few years. The fund’s good performance attracted savvy investors, culminating in an allocation from a university endowment.
Illustrative hedge fund start-up stories like this were thick on the ground 10 years ago. As 2017 opens, the hedge fund industry is radically changed, in good and bad ways. Here are four key changes that have benefited investors and four that have worked against them.
First, it’s arguably easier to get basic information on most managers and their strategies in these once-elusive investment vehicles. Since 2012, most hedge fund managers with $150 million or more in assets under management have been required to register as investment advisors with the Securities and Exchange Commission. The agency’s Investment Advisor Public Disclosure site provides access to considerable information, including the names of the managers, addresses, telephone numbers, investment strategies and assets under management — information that used to be largely the domain of consultants and funds of funds.
On the flipside, even more information might have been accessible if the Jumpstart Our Business Startups (JOBS) Act of 2012 had gained any meaningful traction with respect to hedge funds. The act relaxes a long-standing ban on general solicitation and advertising by various privately offered investment opportunities, including hedge funds (but only if certain conditions are met).
Although the JOBS Act allowed meaningful new pathways to asset raising in other sectors (e.g., crowdfunding), the conditions to be met to take advantage of the new opportunity present operational and compliance challenges within existing distribution networks. Few hedge funds to date have taken advantage of the new opportunity to publicly advertise their wares.
Second, I believe the compensation model has improved. A decade ago, hedge funds typically offered investors a Hobson’s Choice; pay a 2% management fee and a 20% performance fee — or scat. Pressure from billion-dollar pension funds and other institutional investors has challenged the “heads I win, tails you lose” approach. Some hedge funds are offering lower fees offered for longer lock-ups and reducing management fees as fund assets rise.
Still working against investors is the relative rarity of “claw backs,” where a share of past performance fees get returned to investors during periods when the hedge fund loses money.