Whether that continues to be the case in the future as the new rules become part of the landscape, only time will tell.
Reason #3: Hedge Fund General Partners Can Admit Who They Want
The managers, general partners, and other executives of a hedge fund can accept or reject whomever they want into the fund without reason, discriminating at will. It isn’t the same as investing in mutual funds or investing in stock where anyone who can afford to buy shares is entitled to do so. This can benefit the hedge fund in a lot of ways. For example, the portfolio manager can make sure only like-minded investors with the same capital allocation policy are admitted, minimizing future conflicts and distractions. Unfortunately, it also means that outsiders have a harder time gaining access if they aren’t already within the orbit of someone invested in, or otherwise connected to, the fund. This is an area where private banks and wealth management companies can play a role, introducing investors to fund managers and visa versa.
A perfect example is the most famous investor in the world at the moment. When Warren Buffett started his hedge funds, unless you were connected to him, his family, an existing investor, or his mentor, Benjamin Graham, you likely wouldn’t have heard of him. His original seven partners included family members and his college roommate’s family.
Reason #4: You May Not Meet the Minimum Investment Requirement for the Hedge Fund
The person or people running a hedge fund can set the minimum investment at whatever he or she wants in most situations. Since there is a limit to the total number of investors that can be admitted under a Regulation D Rule 504, 505, or 506 exemption, they are going to want to make that figure high. Some hedge funds require a minimum investment of $100,000, while others may require $25,000,000 or more! It is simply a matter of efficiency.
I ran into this myself when my husband and I began planning the launch of our upcoming global asset management firm. One of the first services we are intent on rolling out is known as a private account. While not a hedge fund, and thus not subject to the securities regulations that we are discussing in this particular passage, this type of arrangement will allow affluent and high net worth individuals, families, and institutions to establish an account at a third-party custodian of their choice and then give our firm discretionary authority over it; authority that we use to build and maintain a bespoke portfolio for them using the same investing philosophy we employ when managing our own family’s wealth. In many ways, it’s like having a private mutual fund created specifically for you; a way to attempt to combine the tax advantages of individual securities with the convenience advantages of outsourcing the entire job to a professional portfolio manager. It also tends to involve fees that are a lot lower than a hedge fund, albeit with more restricted mandates. For example, a hedge fund can take out bank debt and acquire entire companies, which you can’t do with a private account as we are setting them up.
When we were working on the structure, I was originally tempted to set the minimum investment at between $1,000,000 and $5,000,000. It was my husband who convinced me, after many, many afternoons and evenings of discussion, to lower it to $500,000. Even still, when I announced it, I heard from a lot of people who were disappointed. I’ve been trying to find a way to effectively get the minimum down to $250,000, at least in the beginning for people who are on the waiting list, which is still far beyond the reach of the typical American household.
I didn’t do it out of a desire to exclude. The reality is, it’s simply too hard to service smaller accounts to the standards I want for my firm and I am not interested in charging the kind of fees so many regional banks and trust companies do. That means having to shut the doors to a massive swath of society. It’s a pragmatic decision based on a trade-off analysis and the numbers. Perhaps, one day, we’ll launch mutual funds or exchange traded funds of our own to make our services accessible to smaller clients in the way other companies have – there are unquestionably less affluent investors out there who share our affinity for passive investing, a value-based approach, and tax efficiency – but it’s definitely a challenge.
Finally, Don’t Forget That a Hedge Fund Isn’t a Type of Investment, It’s a Generic Term That Covers the Waterfront and Is Impossible to Classify
When someone says they bought a “hedge fund”, it doesn’t really tell you anything. A hedge fund isn’t necessarily a good investment anymore than a stock can be good or bad. It is merely a descriptive term that tells you that you are dealing with some sort of pooled investment fund that is probably not registered with the SEC because it falls under one of the Regulation D exemptions. You could have a hedge fund that specialized in buying and selling hotels, one that bought stocks on a value investing basis, one that traded fine art, or one that bought and sold rare stuffed animals! The hedge fund could be debt-free or highly leveraged. It could focus its activities on assets within the United States or abroad. The list of possibilities is endless.