There are plenty of excited articles around these days about the new JOBS (Jumpstart Our Business Startups ) Act and the effect this new law will have on the marketing of hedge funds. In brief, it’s now going to be easier for hedge funds to market themselves to the general public. If previously hedge funds ever thought of running ads on TV or radio, or writting guest promos on blogs and social media, they would have been restricted by a legal prohibition against such things. The JOBS Act changes that.
Another big change is that hedge funds, rather than having to collect only really large sums of money from wealthy people, will now be able to raise up to $1 million a year in small amounts from people not previously allowed to invest in such vehicles. Remember all the complaining that only the really rich had access to the elite performance hedge funds were able to provide? That protected a lot of little people from Bernie Madoff, but never mind – now the little people will have the same chance as everyone else to make a lot of money or, if not hand it to a criminal, invest with someone who won’t deserve the huge fees he will be charging.
Now say you are thinking of putting money in a hedge fund, or are given the task of checking out a prospective hedge fund for your client. The hedge fund has been around for three years and has pretty good returns. What else should you look at? We’ve written in “Allen Stanford: Persistent Due Diligence Could Have Made a Difference” about the huge red flags Allen Stanford had flying if investors had just cared to look. Bernie Madoff, aside from his tiny auditor, declared with the SEC just a fraction of the stocks under management he was supposed to have had.
In the interest of avoiding such disasters in future, here for starters are some of the questions would recommend:
- What funds did the principals run before? Hedge funds can (and often do) close up shop when they don’t do well. They return money to investors and dissolve. But what about the managers of those poorly-performing funds? It’s accepted practice in the world of hedge funds that managers of failed funds get new investors and open new funds under a different name. Is your manager one of those on the rebound?
- What were the circumstances that caused the old fund to close? Was it the retirement of the manager’s partner, or just sub-par returns? If unclear on this, are there any former employees or investors we could talk to in order to find out what really happened?
- Beyond previous fund experience, have the managers ever been subject to regulatory sanctions? Have they ever been sued by investors or anyone else? If the answer to the lawsuit question is “yes, but the legal matter settled,” we would advise that you retrieve the court documents (manually is usually the way we usually do this, not on line) and then read the allegations made against your manager.
- Finally, you want to make sure the fund is registered where it says it is and the principals are really the people as represented. We’ve written before in “Prevent Corporate Identity Theft: A Consumer’s Checklist“ about preventing corporate identity fraud, and now that hedge funds can advertise you want to be especially careful that the address to which you send your money corresponds to the one in official records.
Will all of this take a little bit of time? Sure. But given that some people agonize for a year about which kind of luxury car to buy, it makes no sense to us that cocktail party chatter alone should be the basis for an investment worth several Porsches.
Due diligence isn’t as much as fun as the Porsche showroom, but failure to do it right could mean a downshift to a Hyundai when you least expect it.