July 28, 2014

Most following the hedge fund industry are acutely aware that globally, hedge funds have more than $2.2 trillion in assets under management (AUM). This is a staggering sum by any measure and it continues to grow quarter over quarter. However, mutual funds remain the single largest draw for investor dollars, with $30 trillion in AUM world-wide, $15 trillion of which reside in the United States.

This roughly fifteen-fold disparity is the consequence of many factors, not the least of which is the wealth test that potential hedge fund investors must pass to join the club. Although the JOBS Act has liberated hedge funds from the shackles of the ban on general solicitation, it has not eased the membership requirements for participation. As a result, the soup du jour for the majority of retail investors will continue to be mutual funds. However, a substantial number of mutual fund investors are capable of meeting the required criteria for transition to a hedge fund.

The Hedge Fund Mystique

Lets face it mutual funds are terribly dull. Moreover, mutual funds do not enjoy the mystique associated with hedge funds. Astute, market savvy mutual fund managers recognize that absent the ban on general solicitation, there is a very real possibility of losing investors to the comparatively provocative world of hedge fund investing. Hedge fund managers should be working aggressively to make that happen—but very few are making the effort.

In contrast, more than a few proactive mutual fund managers have taken steps to recast their fund’s image in a manner that more closely mirrors strategies employed by hedge funds, yet requiring asset minimums as low as $1,000.

For example, mutual funds such as State Street Global Advisors, enabled by the repeal of the so-called short rule, launched a fund with a hedge-sounding name, Global Alpha Edge, which featured a blend of long and short positions, even before the solicitation ban was lifted. Other mutual funds are being offered to investors as “market-neutral”, implying returns in good times and bad. There are also mutual funds offering a “fund of funds” approach.

These imitations, although flattering, should be serving as a clarion call to hedge fund managers. If mutual funds are concerned enough about client retention to mimic hedge fund rivals, then it stands to reason that genuine opportunities exist for hedge funds to capture some percentage of this lucrative retail market … some percentage of $30 trillion.

Efforts Disappoint

To date, there is little evidence that hedge funds are making any serious effort to turn qualifying mutual fund investors into hedge fund investors. The reticence is understandable. The decades-long ban on solicitation has a momentum that is difficult to overcome.  Add to the equation the fact that most hedge fund managers look at the cost/benefit of marketing with the same analytic mindset employed in evaluating an investment and it isnt helpful that the ROI for marketing costs is a significant unknown in the hedge fund industry.

With trillions of dollars in play, hedge funds must overcome these concerns and forge ahead. The retail market is huge and every effort should be made to tap it.