Increased demand for due diligence on hedge funds--if not for the funds themselves--may be the initial impact of the Securities and Exchange Commission's recent ruling lifting an 80-year-old ban on advertising for private offerings.
"I think wealth managers will be getting a lot more requests for information about hedge funds," said Greg Curtis, chairman of Greycourt and Co., a Pittsburgh-based family office with $10 billion in assets under management. "It won't be a problem for us, because we're already doing a lot of vetting for our clients. But for people who never thought about it, there's going to be more interest, and more need for evaluation."
'ASKING MORE QUESTIONS'
The more exposure clients have to hedge funds, the more their interest is likely to be piqued, said Caleb Silsby, senior portfolio manager at Whittier Trust in South Pasadena, Calif.
"People will begin seeing information about hedge funds in multiple places and it will stick with them and be reaffirming," noted Silsby, who said he already screens hedge funds for clients. "I think we will absolutely see more interest, and as their comfort level rises, they will start asking more questions."
The SEC ruling didn't lift all restrictions on hedge funds. Private funds will still only be able to sell to "accredited investors" who have a net worth of at least $1 million, excluding their primary residence, or more than $200,000 in annual income for the past two years.
But critics and consumer groups contend that this definition is out of date and sets the bar too low. They also say the SEC did not include enough investor safeguards to prevent widespread fraud and abuse.
As a result, wealth management firms will have to make hard choices about how to approach the market, executives said.
"These are complex offerings, and there will be more scrutiny as they become more available," said Brian Heapps, president of John Hancock Financial Network. "Firms will be especially sensitive when it comes to sales to senior citizens."
Hedge funds will also need to be analyzed through a different lens than stocks and bonds, Silsby noted. "The most important consideration when evaluating hedge funds is to understand the risk involved," he said. "A hedge fund is a structure more than an asset class, which means that the underlying risk characteristics can vary widely from one fund to another. Furthermore, the risk of the underlying securities is often compounded by leverage within the fund."
UPTICK IN BUSINESS
As a result, outside firms that specialize in due diligence are expecting an uptick in business. "A lot of advisors are reasonably adept at operational due diligence," said Randy Shain, founder of BackTrack Reports, which specializes in investigating hedge funds. "But they will need help doing background checks and other aspects of due diligence--such as where a hedge fund keeps its money, who it is audited by, how it administers its assets and whether they have done what they indicated they would do."
Not all wealth managers expect to be affected by the SEC hedge fund ruling. "I don't think it will impact my business," said Todd Morgan, senior managing director at Bel Air Investment Advisors. "I don't think the kind of person who has enough money to buy into a hedge fund will be greatly influenced by advertising. I don't see it happening.
"Plus," he adds, "the majority of hedge funds are poor investments. We have ultra high-net-worth clients, and less than 10% are invested in hedge funds."
And not every hedge fund will start advertising, said Wallace Head, principal and vice chairman of Chicago wealth management firm Gresham Partners.
"We expect very few, if any, of the managers we use that are in hedge fund format will advertise--because they are closed to new investors or, if they aren't closed, they are very selective in who they want as investors," Head said. "Most of these managers are not on platforms, they limit the amount of capital they will manage, and they don't seek investors who would respond to advertising."