Jeff Benjamin

Investment Insights: The Blogblog

Jeff Benjamin breaks down the game for advisers and clients.

It is well-past time to expand access to hedge funds

Paris Hilton can invest in such funds, but I can't

Nov 20, 2013 @ 2:06 pm

By Jeff Benjamin

hedge fund, investors, accredited investors
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Now that the Securities and Exchange Commission has made public its plans to re-evaluate the current rules establishing investor access to private investments such as hedge funds, we should expect the familiar battle lines to start re-emerging.

As my colleague Mark Schoeff Jr. reported on Tuesday, Securities and Exchange Commission Chairman Mary Jo White is considering changes to the criteria that must be met to be considered an accredited investor, which likely would expand the market of potential participants in the market.

Currently, only investors who have a net worth of $1 million, excluding the value of their homes, or an income greater than $200,000 can buy unregistered securities or invest in private-equity and hedge funds.

Ms. White, along with other advocates of revising the accredited investor definition, support some revisions that might include qualifications related to financial literacy, industry knowledge and actual experience with complex investment strategies.

Perhaps ironically, that basically describes most financial advisers, which means an expanded definition of an accredited investor could represent a new value-added benefit of working with a financial professional (if regulators decide a trusted adviser can act on behalf of investors as a kind of financial intermediary).

Opposition to any expanded access to an asset class often described as dark, dangerous and overly expensive typically begins by putting forth hypothetical victims that could lose it all to some dubious hedge fund manager who might bet too heavily on an obscure currency trade or go short the S&P 500 over the past five years.

That could conceivably happen, but we all know you don't need a hedge fund to lose money.

Just ask anyone invested in the U.S. Global Investors World Precious Minerals Fund (UNWPX), which is down 48.7% this year. Or the Fidelity Select Gold Fund (FSAGX), down 46.7% this year.

We saw similar arguments against changing the access requirements a few years ago, the last time anyone seriously talked about revising the accredited investor definition. One difference is that at that time, the talk was all about raising the investor net-worth requirement because some special interests were worried too many regular folks are now making enough money to meet the income requirement to invest in hedge funds.

A couple of points that much of the opposition seem to be missing include the fact that, regardless of how regulators want to define accredited, the private investment universe is still controlling and restricting access primarily by setting investment minimums well beyond most investors' reach.

Restrictions related to the number of investors, or limited partners, allowed to participate in most private investment structures also exist, which gives hedge funds another incentive to keep minimums as high as possible.

I'm not suggesting that hedge funds are beyond reproach or immune to scandal, or that investors don't need regulatory protections.

But arguing for the status quo, or even a more restrictive version of the status quo, is not really helping anyone — with the exception of any industry that competes with hedge funds for investor money.

One might need to be a millionaire to invest in most hedge funds, but no such restrictions prevent anyone from buying into something like the disastrous Facebook IPO, investing in an inverse or leveraged exchange-traded fund, or even putting 5% down on a mortgage that effectively represents 95% leverage on an extremely illiquid and long-term financial commitment.

The bottom line is, the current accreditation rules are antiquated and potentially obstructive because they could be preventing investor access to products they might actually need.

If there must be qualifications and restrictions on investor access to private investment vehicles, one's income or bank account should be a minor consideration.

As much as I tried to resist the Paris Hilton example, you only need to ask yourself if the overcelebrated socialite and heiress to the Hilton Hotels fortune is more qualified to invest in a hedge fund than your average financial adviser.

The current SEC rules say she is.

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