It’s been one week since the SEC made an unprecedented decision to strip the multi-decade old ban on general solicitation by hedge funds, and the potential implications are endless. While we often stand up and tell anyone who will listen that managed futures are not hedge funds… in this case – the privately offered funds of managed futures programs are surely part of ”hedge fund advertising’.
So is a scene like this coming soon?
Now, the privately offered funds of managed futures programs are called Commodity Pools within the industry, and the managers who run such pool must become registered with the CFTC and NFA as Commodity Pool Operators. This means they are subject to periodic audits, have to submit quarterly reports on their balances and positions, and coming soon – give access to their bank accounts for the NFA to automatically check that the money is where the fund says it is (sorry aspiring Madoffs.)
The problem from an asset raising standpoint with a Commodity Pool is that a pool is technically a privately offered security – meaning you can’t market it or advertise the offering in any way. Strictly speaking, that means no posting it to databases such as BarclayHedge, no soliciting at conferences such as AlphaMetrix and the CTA Expo, and so on. And just to confuse things – commodity pools are regulated by the National Futures Association (NFA), but the NFA has no rules saying that a commodity pool can’t be solicited to the general public. That rule comes from the SEC (the securities regulator), because a pool is technically considered a security, even though it is registered with the futures regulator.
So what does this landmark ruling by the Securities folks mean for the commodity pools/managed futures funds sort of caught in between securities and futures regulations:
Overview: This is good news for us and the industry… maybe. There’s no reason managed futures funds shouldn’t be able to advertise, seeing as how it doesn’t stamp out the metric ton of regulation requiring disclosures and disclaimers and all that fun stuff. The paperwork to allocate is still thick enough to kill a nasty spider. And when a mutual fund can put an advertisable (is that a word?) product together which invests in these very funds – it only seems fair to let the fund themselves compete.
History: A quick history lesson for those of you who are familiar with the previous rule. Before there was such a thing called, “Hedge Funds,” there was a rule by the government barring private unregistered investments from advertising. It was created in response to the Great Depression when many a scamster advertised investing in this and that snake oil company with little to no company actually behind it. The idea to get rid of it was packaged as a way to generate jobs and spur the economy, by allowing smaller companies to utilize crowd funding to buy equipment, hire more employees, etc. with the money they raise publicly via their advertising method of choice. But with hedge funds being a little more than private companies (who don’t build or sell anything – rather they invest and trade the capital of the company), the law is more likely to be used by them than the local ice cream shop looking to buy a waffle cone maker.
The Vote: 4 of the 5 on the commission approved the change, the one disapproving was commissioner Luis Aguilar, citing lack of protections as the reason for his vote in a FIN alternatives article.
“Without common-sense protections, general solicitation will prove a great boon to the fraudster,” he said. “Experience tells us that this will lead to economic disaster for many investors.”
What this Means for Investors:
1. There will likely be a huge increase in the number of people trying to separate you from your money. Most of it will be dangerous and no good, some of it will be new and exciting (and ultimately no good), and some of it will be the real thing – very talented small to midsize managers who are just trying to expand their reach.
2. There will be a big learning curve for most investors, where they need to get up to speed on the language of funds (custodians, administrators, sponsors, trading advisers, auditors, and more), the unique structure of funds (money pooled with other investors, separate classes of investment, gates, redemption penalties, and more), and the unique fee structure of funds (sponsor fees, admin fees, management fees, incentive fees, and the break-even point of all those).
3. There will be more fraud, with the fraudster who used to raise a few million off his local community now able to perhaps raise a few hundred million off the entire country/world via advertising.
At the end of the day, advertisements, by their nature, are not overly informative, so we’re not sure where this leads the average investor. If it means more managed futures funds are willing and able to talk about their programs in a public fashion, awesome. Come talk about your fund on our blog! If it means a bunch of 30 second spots which do next to nothing in terms of educating investors, and instead appeal to their greed and fear instincts to raise money – we’re in trouble.
What this Means for Managers:
1. The high rollers with endless money probably don’t want to get their feet wet with this one, although you may see something like our photoshop wizardy above to build brand awareness/meet manager egos. But many large funds are notorious for their conservative stance towards new investors, fearing lawsuits. What will they think about advertising – will the risks of lawsuits by investors brought to the fund via general advertising outweigh the (likely small) rewards for many already successful funds.
2. For small and mid-size funds – the risk of advertising will most likely be worth the potentially sizable reward, but the problem there is the small and mid-size pool operators don’t have the money to put ads on CNBC or in Forbes magazine, for example. They will be relegated to doing targeted efforts via digital campaigns and so forth.
3. What do the economics look like? If I’m a big fund and can get a pension or endowment to invest $50 million after several meetings, a few plane fares and dinners (call it 20k in costs), I might have to spend 100s of k in advertising to get 500 $100,000 investors to equal the same $50 million. If I’m looking at a return on investment of just 1/10 my usual efforts, will I find general advertising appealing?
4. Increased NFA scrutiny? The SEC voted against assuming the role of watchdog over such advertisements, meaning it will likely be a free for all on the hedge fund side. But registered commodity pool operators will have to comply with NFA rules regarding communication with the public and promotional material, and have such material subject to review by NFA staff which have been very inconsistent in their interpretations of the rules. (So don’t be surprised if you see an ad for a large fund touting its 45% gain last year, but you are told you can’t do the same thing).
5. Increased competition? Will this even the playing field, allowing small funds to get in front of investors they would not otherwise be able to reach? Or will this be more of the same with the big getting bigger through massive branding campaigns which put a big Winton type fund on the radar of the friend of a friend you are soliciting to invest in your fund. Where he may of never known about managed futures before and you were teaching him how it works and how he can get involved (through you), he may now be left with the choice of the big brand name he knows, and you – the small upstart.
Be like Mike:
Who knows how the future of hedge fund and commodity pool advertising will look, but we can’t help but think back to one of our favorite all time ads, Gatorade’s ‘Be Like Mike’ ad, and envision some hedge fund Jordan is invested in right now trying to find a way to have him shill for them in the same way. Or maybe they’ll take a different tack – asking some celebrity what makes them so rich “It’s Gotta be The Shoes” style: Is it the business? No. The family? No The Hedge Fund…? No… It’s gotta be the hedge fund!