January 29, 2007
RE: Proposal on Hedge Fund Requirements
In my opinion, raising the net worth requirement to invest in private funds worsens a terrible policy. It is my understanding the original legislation was supported by two assumptions: 1) "Unsophisticated investors" should not partake, and 2) Private Funds are more risky. Let me address each assumption separately.
To declare, in general, that less wealthy investors are also less sophisticated is pure nonsense. In my experience, Trustees of Pension Funds, most investment professionals (especially brokers) and virtually all so-called high net worth investors, who are grouped together in what the Commission would consider sophisticated, could not define what a derivative, commodity, or even a mutual fund is in investment terms. And neither, admittedly, could the investing public. The point being each investor, whether in the business or not, may be good at what they do, but the vast majority are not well-educated on basic investment concepts. To rise to the level of sophisticated, I would argue you need to have extensive "classical" education (such as the CFA) in investing and have been managing money directly for at least 10 years. Anything short of that description and you do not qualify. Being a "sophisticated" investor, which I assume means well-versed, has nothing to do with your level of wealth. If given the chance to listen in simple terms, however, about investment concepts, all investors can understand. The larger problem in the industry is that most investment professionals either can't explain things simply or have no incentive to do so.
With respect to private funds being more risky than conventional investments, there simply is no supporting evidence. I challenge anyone at the Commission to produce research which proves empirically that this statement is incorrect. Individual investments are more or less risky than each other when compared side by side, but private funds on the whole are by no means more risky than many other investment opportunities available to the entire investing public, such as stock options, currencies, commodities, and so on. Someone needs to explain to me why an elderly grandmother with $10,000 to her name can plunk all of it in an "Internet" mutual fund on March 1st, 2000 yet not invest in a private fund of diversified stocks managed by a highly-successful fund manager. There is no logical answer to that.
Some better ideas ...
Changing the net worth definition to "invested assets" may have some validity. Or better yet, limiting the amount of investment the average investor can place into a single private fund, makes some sense. It is true that concentrating too much investment with a single manager is imprudent no matter how skilled that manager may be. This goes for any investment, not just private funds. In addition, overseeing the activity of private funds is a good public service after having opened the door for the entire investing public to invest in them. This is no different whatsoever than the current mutual fund climate. Give private funds the incentive to take on all investors, but require them to disclose in simple terms what they do and how they do it and require them to value the portfolio each quarter.
As a matter of disclosure, my business does not rely on profits from private funds. Though I select private funds for some clients, I gain no compensation from doing so.
I urge the commission to think through the law carefully and do what is best for investors, above all else. More choice and less regulation promotes competition and benefits investors of all shapes and sizes.