Lower investment minimums for hedge funds and similar alternative investments may increase regulation of how they are invested and marketed, raising compliance costs for banks and other sponsoring companies, according to several analysts.
Minimum investments of $250,000 to $2 million at most hedge funds traditionally reserved them for the ultra-wealthy. But new hedge-fund-like products with minimums of $25,000 or less are within reach for the affluent.
JPMorgan Chase & Co. began marketing one such product last month — a mutual fund managed by a recently acquired hedge fund firm, Highbridge Capital Management, but requiring just a $10,000 minimum investment.
Some such low-minimum products are subject to the same Securities and Exchange Commission registration and disclosure requirements as any mutual fund. Others are not, because hedge funds themselves are not subject to such requirements.
William Goetzmann, the director of the International Center for Finance at the Yale School of Management, said he expects the SEC to increase regulation of hedge funds and hedge-fund-like products.
“As retail investors increasingly become customers for these products, the SEC will naturally seek to protect their interests,” he said.
Significant hedge-fund investments by pension funds and public endowments may also spur the commission to act, Mr. Goetzmann said. “The SEC may take it upon themselves to protect the public interest,” he said.
David Friedland, the director of the Hedge Fund Association, the industry’s Washington lobbying group, disagreed.
Regulators “have historically taken the view that wealthy and sophisticated investors were prudent enough to look after themselves,” said Mr. Friedland, who is also the president of Magnum U.S. Investments Inc. of Aventura, Fla., a hedge fund firm.
The SEC’s 2004 investigation of the industry, though promoted by the entry of less affluent investors, was not an attempt to institute draconian regulation, Mr. Friedland said.
The trade group expects no regulation beyond the rule that will take effect in February, he said. A spokesman for the SEC said it has proposed no further hedge fund regulation.
Hedge funds are estimated to manage about $1 trillion of assets worldwide, though a reliable figure is unavailable because they are not required to disclose assets under management.
The funds often employ speculative trading strategies and use complex tax structures. And unlike mutual funds, they are generally not bound by rules on potential conflicts of interest, fairness in pricing, leverage, diversification of holdings, or disclosure of fund information, including management, holdings, fees and expenses, and performance.
Funds of hedge funds, like the underlying funds, are illiquid, carry high expenses, and tend not to be listed on securities exchanges. The SEC and the National Association of Securities Dealers Inc. have taken action against several hedge funds in recent years for fraudulent activity.
Matthew Nelson, an investment management analyst at TowerGroup, a research unit of MasterCard International, said lower minimums “will definitely lead to stricter regulations.”
Hedge funds employ several practices that regulators should view as conflicts of interest, he said. For example, many invest in over-the-counter derivatives that they price themselves, he said.
But “there are some questions about the SEC’s ability to monitor and investigate” all the hedge funds that will have to register under the 2004 rule, Mr. Nelson said. There may be 9,000 of them, he said, and the SEC is “woefully understaffed.”
Those that register must hire a chief compliance officer and maintain thorough records, but it is unclear whether these records will actually be checked, Mr. Nelson said.
In addition, because hedge funds need not register unless their “lock-up” period — a time during which their investors are denied access to their money — is two years or less, some are expected to circumvent the rule by extending their lock-up periods, Mr. Nelson said.
But Mr. Friedland of the Hedge Fund Association said, “We don’t believe regulating and restricting managers has been the intent of regulators.” The SEC “simply felt it was necessary to get a handle on who’s out there managing hedge funds,” he said.
