From: Jerry M. Easterly
Sent: January 29, 2007
Subject: File No. S7-25-06

I would like to see Hedge Funds more available to the general public rather than less available.

Here is my suggestion taken from the weekly newsletter of John Mauldin. You can read the entire article at:

The Hedge Fund Investment Company

Let me suggest the following: the creation of a new type of investment company vehicle. Simply modifying the current mutual fund rules might work, but it is not direct enough, in my opinion. Let's call this new vehicle a Hedge Fund Investment Company or HFIC. Let me describe it first and then outline some of the advantages.

A hedge fund would be allowed to register with the SEC (or CFTC if there is a commodity focus) as an HFIC. They would be required to have an annual independent audit, at least quarterly independent valuations of their assets, and independent administrators, plus they would be subject to SEC or CFTC advertising rules. Nearly all of the rules which apply to mutual funds should apply to an HFIC. There would be few, if any, limits on the strategy the fund could employ, and they could charge a management fee and an incentive fee. They would have to fully disclose not only the relevant risks, but also their strategies, fees, personnel, and management experience.

As with mutual funds, there would be no limits on the number of investors. They would be allowed to advertise within current regulatory guidelines. With certain restrictions outlined later, they would be able to take non-accredited, or average, investors.

As noted above, hedge funds pose a set of different and unfamiliar risks than do stocks, bonds, or mutual funds, not to mention futures, options, and real estate, all of which are available to the average investor today. I would suggest that for a certain period of time, say 7-10 years, an HFIC be limited to investors who could demonstrate a required level of investment sophistication or to investors who used an investment advisor or broker who had passed an appropriate exam demonstrating competency in hedge funds (such as the Chartered Alternative Investment Analyst program sponsored by the Alternative Investment Management Association) or who had a sufficient number of years in the industry.

After the 7-10 year period, when investors had come to an understanding of what an HFIC is, and the funds themselves had developed sufficient track records, the funds would then be available on an equal basis with mutual funds, stocks, bonds, futures, real estate, options, and the host of other risky investments currently available to the average investor. This time period would also allow for a support industry and independent analysis firms to develop.

The simple fact is that most institutional funds hire outside analysts to evaluate and recommend hedge funds. They also hire consultants and outside managers to recommend stocks and bonds. The actual individuals sitting on institutional and pension boards do not make the initial investment decisions, although the final authority is in their hands. I would suggest for your consideration that many of the people on these boards are not accredited investors. Yet they are considered capable of evaluating the appropriateness of whether to invest in hedge funds. The evidence is that increasingly large numbers of them are doing so.

They are no different than the individual smaller investor. If you create a situation where they can access appropriate sophisticated advisors, they will do so. Indeed, they do so now. There are tens of thousands of advisors and brokers who offer investment services to the public. They simply do not have hedge funds as a choice.

Would hedge funds willingly register? Because of my involvement in the hedge fund industry, my belief is that they will. To say that there are thousands of funds who are seeking money is not an exaggeration. The problem today is that they must do so privately and only to high-net-worth investors and institutions.

If they could approach a new class of investor, I believe many of them would do so. The current rules do not allow them to do so, and so they do not. It is not the desire of the industry to be secretive, it is the requirements of the law. Most hedge fund managers would have no personal bias against small investors. The reason hedge funds avoid small investors is primarily legal. The large majority of managers simply want an appropriate amount of money to manage. If the rules allowed for appropriate and knowledgeable investing by smaller investors, they would adjust their programs to accept them.

A few comments on what might happen in the real world if an investment vehicle like the suggested HIFC came about.

The likelihood is that a large majority of the initial HFIC funds would be existing funds of hedge funds. Many of these have long-established track records and are well diversified. The process of taking numerous smaller investors would be no more problematic for a fund of funds than for a mutual fund. Certainly those funds of hedge funds that are registering under the currently available system anticipate taking many investors.

Secondly, I think this approach is likely to drive down fees over time. Just as the outrageously high fees of commodity funds came down in the '90s as more funds became available, and many mutual funds are available with quite low fees, I think you would see an investor-friendly fee structure develop, especially for funds which are similar in nature.

The advantage of developing a new fund structure is that it does not displace the current status quo. If a fund wishes to remain private, it can do so. If it wishes to jump through the hoops of registering, that avenue would be available.

The reality is that the disclosures I suggest above are no more than what hedge funds already do today. High-net-worth investors today typically ask for and get the information mentioned in order to evaluate a manager. Thus, as time went on, managers with good programs and steady risk-adjusted returns would realize that an HFIC required no more than their current high-net-worth clients required on a private basis today. The HFIC would simply be seen as another way of raising funds.

This new industry would grow slowly, as did mutual funds when they were first offered. Over several decades, I would suggest that HFICs would become standard fare for investors. They would not replace mutual funds or other investments; they would simply be one more choice, just as they are now for the rich.

Thank you,

Jerry M. Easterly
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