Hedge funds are viewed sceptically by much of United States law. Though the firms are allowed to make big bets on almost anything they want, they face several restrictions on the way they operate, and particularly on the way they deal with the public.
One of the biggest restrictions placed on the investment vehicles is their inability to advertise their investment services to the public. Mutual funds are currently restricted to only advertise using standardized formulaic language, reporting returns and such to the SEC.
Hedge Funds Advertising:
Hedge funds, under current rules, are not allowed to advertise at all. New rules, that are due to come in as part of the JOBS Act, may change the restrictions on hedge fund advertising, and may result in a greater ability for those funds to reach the public.
A new report, authored by Yan Lu of the University of Florida, David K. Musto, of the University of Pennsylvania, and Sugata Ray, of the University of Florida’s Warrington College of Business Administration examines the changes the new law will make and the implications of the changes.
The JOBS, or Jumpstart Our Business Startups Act would grant funds a license for general solicitation. That part of the act has been delayed by former SEC Commissioner Mary Shapiro, because of restrictions from investor groups and others, according to the paper.
The paper takes a look at the current type of hedge fund advertising that takes place in “side by side” funds, those run by institutions that manage both mutual and hedge funds. In these cases, according to the authors of the report, hedge funds benefit from mutual fund advertisement indirectly.
Analyzing the data, the report finds that controlling for performance hedge fund advertising is strongly tied to hedge fund inflows. Hedge funds with low net inflows are more likely to spend on advertising. It’s also clear from the data that advertising for hedge funds works.
After ads, hedge fund inflows increase. The problem is, and this is the crux of the issue, that in the time after inflows increase, style adjusted returns tend to decrease. The findings highlight a current inequality among hedge funds, with those matched by mutual funds being able to advertise, and those working in a hedge fund only environment being unable to do so.
The paper does little to examine where the additional money would come from. It is not clear whether hedge fund advertising, with the industry’s current state, would be competitive, and leave the market at its current size, or expansive and add to the size of the market.
This paper is the first in what is sure to be a number over the coming months and years examining the effects of advertising on the hedge fund world. If the JOBS Act provisions that allow advertising to commence are implemented, the hedge fund world will change dramatically, and a good deal new money could be attracted into the hedge fund world.
The bottom line, according to this report, is that hedge fund advertising works. If it comes into being in the future, hedge funds that currently do not operate side by side with mutual funds will see the most benefit, but side by side hedge funds may also benefit by being able to advertise hedge fund products more effectively.
Hedge fund advertising is probably coming. The provisions for advertising have not been written yet, but that day should come. The effect on the general marketplace, apart from the conclusion that inflows into funds would increase, is not known, but they will surely be dramatic.