Monday, September 03, 2007

Hedge Funds - Everyone Able to Invest?.. Why Not?

Earlier today I was reading (a good resource, take a moment to visit) and I was interested in their question 'Should unsophisticated investors be allowed to invest in hedge funds?'.

This, as you may have seen from some of our posts is a subject which can get our heckles up fairly quickly. The blog has some valid points about protecting mom and pop from being burnt by unscrupulous managers, but I think the issue is deeper than just the question...if you know what I mean..

OK, let me explain. "Should unsophisticated investors be allowed to invest in hedge funds?"..


and Yes.

But mainly No.

Difficult question. Lets take three examples:

Johny Smart-Pants is a a 22 year old tech wizard who makes $200,000 a year. He has saved $100,000 and decides he wants to take a risk and fancies this hedge fund malarkey. He knows nothing about investments but likes the idea of the risk/reward. If he loses it, he will be mad but not broke.

Should he be allowed to invest? Why not?

Have him sign a waiver saying that he has read all the risks warnings, knows he can lose his money but still wants to do it anyway. Free country right?

Another example, Mrs Daisy Dotes and Mr Dosey Dotes want to invest some money for there little amsey diveys, but are happy to risk some of the funds. They are 65 both retired. He was a stockbroker, she was a housewife who dabbled in the markets and is of intermediate knowledge, he has followed hedge funds, knows the risks and decides he would like to invest.

Should he be allowed to? Probably not... but then again why not if he is happy to take the risk?

Third example.

Mr T.R. Uck-Driver made $10mn from his trucking business. One of his golf club pals told him about hedge funds and he wants to invest $1mn. He knows nothing whatsoever about the stock market..

Should he be allowed to invest?... wait a minute... he can, with nothing more than an accredited investors form...

It's madness.

We believe solidly that freedom for individuals to invest in whatever they want whenever they want is a paramount pillar of being in a free society, however, there needs to be protections in place, but that is not only the regulators job. It is the fund manager that accepts the money.

A very easy situation to implement would be one where the regulators laid down rules for investment into hedge funds where the sophistication and the circumstances of the client were taken into consideration by the fund before they invest (much like the 'know your client' for every other investment). A decision is made by the compliance department of that firm as to whether they take on the client or not. This would be based on many factors, the ability to replace funds lost, age, sophistication, percentage of net worth, etc etc.

Simply saying that someone with over $2mn is OK to invest is just..well...silly at best, dangerous at worst.

I understand that you will get managers whose compliance department is not all it should be and will accept anyone, however, if a client looses money in such a fund then he/she should have the right to recover that money from the fund for negligence. Surely this method would level the playing field for all investors to consider all investments.

Many people don't know about and don't care about hedge funds, but are being excluded from accessing funds because they are not rich enough. Why on earth is the principal of this not being discussed? Think about it.

If you want to jump of a cliff with a parachute attached (or not), go bungy jumping off a dam somewhere, or, in Switzerland, legally have an assisted suicide, you can, no problem. But because some bureaucrat says you are not rich enough, you can't invest in a hedge fund..

In our opinion, whether you want to or not, there should be a right for anyone to 'apply' and the fund manager should consider your application and be allowed to accept or deny it on his or her terms. Anything else is as elitist as the the secret fraternities and the London gentleman's clubs and for countries that claim to have a democracy, it is not very democratic, is it?

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