New rules proposed by the Securities and Exchange Commission could shrink the pool of investors for hedge funds and limit opportunities for some fund advisers to reap performance-based rewards.
The proposal would raise financial requirements for investors to whom hedge fund and private-equity fund managers could charge performance fees. That would mostly affect small and midsize hedge funds, cutting into their ability to raise capital, industry observers said. Newly registered funds also would be affected, they said.
Advisers who manage hedge funds typically charge a flat fee, based on the amount of money an investor has in the fund, and a floating fee based on how well the fund performs. Often, the charge is 2% of the assets being managed, and 20% of the profits.
Right now, the rules allow managers to charge performance fees when an investor has at least $750,000 under management with the fund or has a net worth of at least $1.5 million, including the value of his home.
The restriction is intended to ensure that only sophisticated, well-off investors put money into hedge funds, which can be risky and illiquid. The amounts haven't been adjusted for inflation since 1998, however. The Dodd-Frank Act calls for, among many other things, an adjustment in July and then every five years. It also requires the SEC to exclude an investor's primary residence from the net-worth calculation, a change sought by investor advocates.
The SEC's proposal, which is expected to be approved in July, would increase the minimums to at least $1 million under management or $2 million in net worth, excluding the value of the investor's primary residence.
"For hedge fund managers and private-equity managers, this is a huge deal," said Myles Edwards, general counsel and chief compliance officer for Constellation Wealth Advisors LLC, a New York registered investment adviser and portfolio manager for two hedge funds.
A hedge fund's current investors would be exempt from the new standards, but funds that are trying to raise capital, such as newly registered funds and private-equity funds, could find that more challenging.
Small and midsize funds that have been shifting toward retail investors to increase their assets under management may find they are competing for dollars from a smaller group.
Large hedge funds, whose investors tend to be institutions or extremely wealthy individuals, won't really be affected, said Ron Geffner, a hedge fund lawyer for Sadis Goldberg LLP in New York. A fund that requires a $1 million minimum investment, for example, would attract potential investors who already meet at least one of the proposed standards, said Geffner, who also is vice president of the Hedge Fund Association, a trade group in Aventura, Fla.
