Registered Hedge Fund Demand on the Rise
August 30, 2004
The number of high-net-worth individuals rose sharply in 2003, a trend that represents a significant opportunity for asset managers offering registered hedge funds, according to a recently released white paper by Financial Research Corp.
The registered hedge fund is a product many manufacturers are "pinning their hopes on" as a way to reach a broader audience and beef up assets under management, according to the study, "Approaching the Registered Hedge Fund Decision."
"These are products that manufacturers need to be aware of [and] understand because they are a way to help retain assets under management as they attempt to target the high-net-worth investor," said Dave Haywood, director of alternative investments at FRC and author of the report.
The registered version of hedge funds attempts to eliminate many of the hurdles or drawbacks of traditional hedge funds while maintaining the product's benefits, such as a low correlation to the equity markets. Hedge funds are not currently required to register with the Securities and Exchange Commission, but that could soon change as the Commission is exploring oversight possibilities of the industry. Those that are registered are either registered only with the Investment Company Act of 1940 or both the 40 Act and the Securities and Exchange Act of 1933.
However, the difference between registered and traditional, or unregistered, hedge funds is more than simple oversight. In fact, it is Haywood's contention that even if the SEC requires registration, the two kinds of hedge funds will likely pursue different markets.
Investment minimums in registered funds are well below that of traditional hedge funds and are generally in the $25,000 to $50,000 range. Unregistered funds, on the other hand, usually have minimums of at least $250,000.
Poor liquidity in traditional hedge funds has always been one of the drawbacks of the product, with managers determining when investors can pull their money out. While there are still some hurdles with the registered variety, investors have greater access to their investments. While managers still have discretion over the liquidity they offer, all registered funds provide for periodic tender offers.
"It is clear that investors are looking for more sophisticated financial products, and manufacturers and distributors are responding to that demand," Haywood said. "Hedge funds have grown at an explosive rate over the last few years both in terms of assets and new entrants."
Currently, assets in registered hedge funds are very small compared to the nearly $850 billion to $1 trillion the industry has under management. Figures of industry assets vary depending on the source. As for registered hedge funds, there are currently about 70 total, with assets of more than $8 billion. However, there are many more in registration at the SEC or on the planning board of investment product manufacturers.
FRC predicts that registered hedge funds will surpass $50 billion by 2007 and $200 billion by 2010. The forecast corresponds to an increase in high-net-worth individuals and is due largely to the Baby Boomer population that has gathered significant independent retirement savings.
Citing figures from a "2004 World Wealth Report" from Capgemini and Merrill Lynch, FRC said the number of high-net-worth individuals jumped 14% to 2.27 million at the end of 2003. And, it is likely that the largest percentage of those are concentrated at the lower end of that range, between $1 million and $2 million, meaning that the target market for potential registered hedge fund investors is on the rise.
That same report showed that 70% of the high-net-worth investors around the world are over the age of 55, a trend that is particularly widespread in North America, according to FRC. In terms of dollars, high-net-worth investors in the U.S. have about $7.6 trillion in assets and those assets should leap to $9.5 trillion by 2008.
Furthermore, trends show that allocation to alternative investments, including hedge funds, managed funds, foreign currency and others, is on the rise, growing three percentage points between 2002 and 2003. The allocation jumped from 10% to 13% in that time frame.
However, before firms get wide-eyed about the possible growth in assets, they should examine the process and be prepared for the drawbacks, Haywood said. So far, the registration process has been "lengthy and fraught with uncertainty." On average, it takes nine months, according to the report. Firms looking to add new features or twists to the product can see the process take even longer.
Benefits of offering a registered product include reaching a potentially unlimited pool of investors, offering lower entrance minimums, and the manager's flexibility in regards to liquidity. The registered product is often structured to enjoy pass-through taxation, and the ERISA fiduciary rule does not apply to registered funds. However, investors must meet eligibility requirements to invest in them. Advertising and general solicitation of business are restricted, and leverage is limited to 33% of assets. Also, fund decisions need board approval.
Ultimately, firms should examine their structure, determining whether their culture, clientele, strategies, distribution partners and internal resources are a good match for the product.