For 80 years, hedge funds and other private investments have been barred from advertising directly to the general public. The ban was meant to protect unsophisticated investors from these barely regulated, sometimes dicey investment pools, which now control more than $2 trillion in assets. This important safeguard, however, is going away; the Securities and Exchange Commission voted 4-to-1 last week to allow hedge-fund advertising for the first time. Experience suggests that some funds will be fraudulent, many will be risky, and unsuspecting people could lose a lot of money. Federal regulators’ next step should be to write more stringent limits on this marketing to protect small investors.
Hedge funds are still restricted to so-called accredited investors — people who have a net worth of at least $1 million or have earned more than $200,000 a year for the past two years. That is still about 7.6 million households, many headed up by baby boomers ready to reinvest retirement accounts that are once again flush due to a booming stock market. In the past, hedge funds couldn’t advertise, so risk-seeking investors had to search them out. Now, these funds will try to solicit a broader base of customers.
Yet despite their exclusive reputation, hedge-fund investments offer no guarantee of profit. In fact, the majority of funds don’t beat the S&P 500 index. Through May this year, hedge funds have returned only 5 percent, compared with 15 percent for the S&P 500 and the average blue-chip mutual fund, according to research from Goldman Sachs. Add in the exorbitant fees that most hedge funds charge, and it surely isn’t regular investors who stand to gain most from these new advertising rules.
The SEC was required to allow the new ads as part of the 2012 Jumpstart Our Business Startups Act, known as the JOBS Act. Hedge funds were lumped in with broader changes allowing many private share issuers, including private-equity funds and start-up firms, to solicit new investment from the public. The idea was that mass marketing would give needy small businesses and entrepreneurs wider publicity to attract financing, grow, and create jobs. That’s a worthwhile goal.
But unintended consequences now loom large: In addition to jeopardizing the savings of individual investors, potential abuse could also destabilize the integrity of the market as a whole. Congress should revisit this aspect of the JOBS Act. In the meantime, regulators must be on the lookout for dodgy ad pitches that put investors at risk.