Hedge Fund Managers Launching Mutual Funds in an Effort to Stay a Step Ahead of Regulatory Convergence
Hedge Fund Law Report
Although the term “hedge fund” has no statutory or common law definition, historically hedge funds have been defined in large part by what they are not: mutual funds. Unlike mutual funds, hedge funds have been exempt from the definition of “investment company” under the Investment Company Act of 1940, and unlike mutual fund advisers, hedge fund advisers have not been required to register under the Investment Advisers Act of 1940. Free from many regulatory restrictions that bind registered funds and advisers, the hedge fund format has been understood as a blank canvas on which a creative manager can realize his or her full investment potential; and the historical returns of some managers have borne out that understanding. However, in a potent sign of the extent to which the challenging economic climate has changed the hedge fund industry, hedge funds managers are now engaging in a move formerly considered unthinkable – they are launching mutual funds. While there are various reasons for this trend, two macro variables are largely responsible. First, the negative feedback loop of poor performance and redemptions that has virtually halved the capital base of the industry. Without capital there are no hedge funds – or mutual funds – and so hedge fund managers are looking for new sources of capital to fill the holes left by redemptions, even if that new capital generates lower fees. Second, the increasing likelihood, perhaps inevitability, of regulatory convergence between hedge funds and mutual funds, and their respective managers. Bills presently before Congress would subject hedge funds and their managers to many of the regulations currently applicable to mutual funds and their managers. If such bills pass – and the consensus view is that they will, though likely with modifications from their current forms – then the regulatory playing field will be leveled and the legal advantages of running a hedge fund over a mutual fund will largely disappear. In this sense, launching a mutual fund constitutes a recognition by a hedge fund manager of what may well be a legal fait accompli, and an effort to capitalize (from a marketing perspective) on the “aura” of being a hedge fund manager while that still means something in the retail imagination. We discuss the convergence trend, the benefits and burdens to hedge fund managers of running a mutual fund, which hedge fund strategies lend themselves to mutual fund structures, allocation and marketing considerations and competition issues.