A New Market for Hedge Funds by Sam Madden.
On 10 July 2013, the US Securities and Exchange Commission (SEC) voted 4–1 to lift a decades-old ban that has prevented hedge funds and private equity firms from marketing their investments to the general public. This move opens up billions of dollars of new capital from potential individual investors — money that funds can now focus on from an advertising and marketing front.
New Target Market
For individuals to be legally allowed to invest with hedge funds, they must be deemed to be “accredited investors.” The SEC estimates that approximately 8.7 million US households (or 7.4% of all US households) fall into the accredited investor category. The breakdown of this household network by net worth can be seen in the chart.
What Will Hedge Fund Marketing Look Like?
Funds looking to tap this new capital pool can now appeal directly to the consumer. This change means that a variety of new marketing tools will be available to hedge funds, such as traditional advertising (e.g., CNBC TV ads, WSJ.com ads), sponsorships (e.g., investment idea seminars, business TV programs, sporting events), and alternative tools that are idiosyncratic to the hedge fund model (e.g., investment research promotion, track record marketing).
Why This New Rule Makes Sense for Funds and Investors
As long as funds don’t have to deploy large amounts of marketing dollars to attract this new capital, it’s almost a no-brainer for funds to take on new investors and money. Thousands of small funds (which can be colloquially defined as having anywhere from $5 million to $500 million in assets under management) have all been chasing the same amount of capital, to the point where industry pricing has dropped over the past few years due to high competition.
Individual investors are benefiting because of hedge funds’ outperformance of the market and also because this “new” asset class, which has historically only been open to the uber rich, is now available to a new demographic. As a result, individual investors have access to a new portfolio diversifier with less volatility and higher returns than they can get from simply buying equity indices.
How to Efficiently Tap This Market
As this new wave of investors begins to take shape, both hedge fund and retail investor markets must be served. That is to say, funds need to be able to recruit this new capital in a seamless yet effective way, and investors need to be presented with hedge fund data and information in an “easy to interpret” format. Some key thoughts around this topic are as follows.
- Because smaller firms are cost conscious by nature, small funds will want a marketing strategy
that is as low cost as possible (or free). Managers will not want to spend meaningful capital paying a public relations company or even a third-party marketer to chase down new capital.
- As a tangent to the first bullet, smaller funds are also lean, focused on investing, and not set up to add more manpower for a separate marketing department. An easy and efficient way (or platform) to get their ideas, strategies, and track records out to the masses would be ideal for smaller funds (e.g., research publishing, video marketing).
- Fund managers also will want to get their names and ideas out to as many people as possible. With 8.7 million households as potential customers, it will be imperative to cast a wide net to ensure all potential investors are aware of the new asset class available to them.
- Like any other type of investor (e.g., institutional, retail), individuals will want to know the
track record of the fund as well as the pedigree of the fund manager(s) — how long the fund has been in existence, return performance of the fund to date, credentials of the fund manager(s), etc.
- Another crucial detail is the strategy and focus of each fund. What asset class (e.g., equities, credit, real estate) does the manager specialize in? What industries are the focus of investments? Is there a hedging strategy in place (e.g., short, options)? Investors like to know these details so that they know how to manage the rest of their personal portfolios from a diversification perspective. Also, from a psychological perspective, it makes sense to know where their money is.
- Investors also like to know how managers think about and analyze investment ideas. Funds that share their investment analysis and research with potential investors have the upper hand in attracting new capital from said investors. Individuals will get a chance to see what exactly determines a good investment for these fund managers and how they go about evaluating companies and industries.
This drastic shift in marketing regulation has just occurred, so it is still in its infantile stages. I would not be surprised in the coming years to see numerous third-party marketing firms develop tools to help hedge funds raise capital from this new and large market of capital. The winning strategy, however, will be platforms that fulfill the needs of both funds and individuals (as discussed) in an efficient and powerful manner that satisfies the former’s needs for capital and the latter’s need for information.
This was previously published on Inside Investing at the CFA Institute.
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Sam Madden, CFA, is the founder of InteractiveBuyside, a distribution & marketing platform enabling investment professionals to share their research with a broad-reaching network of individual and institutional investors. Prior to founding Interactive Buyside, Sam was co-CIO and CFO of MVR Capital, a long/short hedge fund focused on energy, agriculture and water technologies.
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