The firms most likely to benefit first from new rules that would allow hedge funds to conduct wide advertising campaigns aren’t hedge funds.
BlackRock Inc., the world’s largest money manager, offers alternative investments and supports the change. So does JPMorgan Chase & Co., the biggest U.S. bank by assets, said two people familiar with its position, who asked not to be identified because the matter is private. The companies have the marketing breadth to seize the opportunity, while hedge funds and private-equity firms with smaller promotional teams may be hindered as investors turn to alternatives for higher returns.
The Jumpstart Our Business Startups Act, signed into law by President Barack Obama in April, ended a ban on the advertising of non-registered securities as part of an effort to expand funding options for startup companies. The law may give the biggest advantage to firms with trillions of dollars in assets and create a divide between asset managers that offer hedge funds, private equity and other alternatives and those that don’t, such as traditional mutual-fund companies.
“The JOBS Act is something where the advantage is for hedge funds, but they don’t have the skills for it and the traditional managers that have alternatives have the capabilities to take advantage of it,” Benjamin Phillips, a partner at consulting firm Casey, Quirk & Associates in Darien, Connecticut, said in a telephone interview.
The U.S. Securities and Exchange Commission is responsible for writing the rules to implement the law and commissioners voted 4-1 on Aug. 29 to invite public comment on their proposal. Comments are due Oct. 5.
The proposed rules say issuers must take “reasonable steps” to ensure the only purchasers of private securities are so-called accredited investors, without mandating what those steps are. Accredited generally means those with more than $1 million in assets, excluding primary residences, or people earning more than $200,000 a year. The proposal has drawn criticism from investor-protection groups and the Washington-based Investment Company Institute, which say consumers may be exposed to misleading advertisements by firms that sell private securities.
The SEC also didn’t spell out acceptable types of advertising, which could allow general solicitation such as television and website ads. BlackRock and others may be able to reach more than 7.6 million U.S. households that qualify as accredited investors, according to government estimates. Private offerings raised about $1 trillion last year, SEC Chairman Mary Schapiro said at an Aug. 29 meeting of the agency.
“We are supportive of the JOBS Act and the SEC’s proposed rule as we believe sunshine is a great disinfectant and it’s time to take private placements out of the dark,” Barbara Novick, BlackRock’s head of government relations and public policy, said in an e-mailed statement.
Lauren Post, a spokeswoman for New York-based BlackRock, declined to comment beyond the statement. Charlotte Powell, a spokeswoman for JPMorgan, declined to comment.
BlackRock, which oversees $3.56 trillion, is trying to expand by attracting assets rather than making transformational deals. It started a five-year branding campaign earlier this year telling clients how to invest in an uncertain market. Chief Executive Officer Laurence D. Fink and other executives have said publicly that investors need to diversify and can be harmed by staying in cash-like products.
The third phase of BlackRock’s branding initiative starts today, with advertisements appearing in the Wall Street Journal and Financial Times and on digital media sites such as Bloomberg.com. The advertisements suggest investors consider a broader mix of assets and put money in exchange-traded funds, high-quality stocks and products that generate more income.
Private-equity and hedge funds can be important sources of portfolio diversification and should be readily accessible to those who are eligible to invest, Novick said in a May 3 comment letter to the SEC.
Last year, BlackRock expanded its alternatives division, which manages real estate, private-equity and hedge funds, and had $104 billion under management as of June 30.
Banks including JPMorgan provide traditional mutual funds as well as alternatives such as hedge funds and private-equity investments. New York-based JPMorgan’s asset-management unit was the world’s third-largest hedge-fund manager, with $46.6 billion in assets, as of Oct. 31, 2011, according to data compiled by Bloomberg. The unit manages $1.3 trillion.
Other money managers that sell alternatives include Goldman Sachs Group Inc., Pacific Investment Management Co. and Franklin Resources Inc., which said it agreed to buy a majority stake in K2 Advisors Holdings LLC, a fund-of-hedge-funds manager, in September. Spokesmen for the firms declined to comment on the advertising opportunity provided by the JOBS Act.
“This is going to allow larger fund complexes to offer a wider array of products to their current clients,” said Adam Sussman, partner and head of research at Tabb Group, a New York-based research and consulting firm. “It opens the door for the retail investor to gain access to new asset classes and new types of investments” as they learn about them.
The advertising change may spur wealthy investors to follow a strategy favored by institutions, Sussman said. Pensions and endowments increasingly are using a so-called “barbell” approach: They invest part of their money as cheaply as they can in passive, index-tracking strategies including ETFs. When they do pay higher fees for active management, it’s for alternative investments such as hedge funds with the most flexibility.
The advertising provision in the JOBS Act was part of a package designed to make it easier for young companies to grow. The loosening of rules regarding the marketing of unregistered securities was meant to help startups and small businesses including fund companies raise money and then hire more workers.
Many traditional hedge funds won’t be well-positioned to market to the general public soon after the rules become official because their capacity for new capital is limited and their infrastructures aren’t designed to double or triple the number of investors, said Ray Nolte, chief investment officer at SkyBridge Capital LLC, a fund-of-funds business based in New York.
“Most hedge funds aren’t set up to be the large mutual-fund complexes with call centers and everything else that handle huge influxes,” Nolte said. They may not change their approach to include mass marketing through billboards and television advertisements because they already have a client base and are protective of revealing too much about their investment strategies, he said.
Large asset managers have “deep pockets” and advertising professionals on staff because they’re in businesses like mutual funds that generally haven’t had restrictions on who to sell to, said Uri Landesman, president of New York-based hedge fund Platinum Partners, which has $1.15 billion in assets.
“It gives them a little bit of an edge, but we’ll make up for it by being smarter, more nimble and having fewer products to worry about,” Landesman said.
Most of the largest asset managers are still traditional players without well-developed alternatives capabilities, according to Casey Quirk’s Phillips. Firms that only offer mutual funds may lose assets as a result of the JOBS Act, he said. Investors have pulled $585 billion from actively managed U.S. stock mutual funds that invest domestically from January 2008 through this August, according to data from the ICI.
“The JOBS Act continues to pile on competitive pressure because they’re not offering non-correlated investment returns,” Phillips said. “Those that only offer mutual funds will look further and further behind.”
The SEC proposal creates a competitive imbalance because it doesn’t standardize how private funds can advertise their performance while mutual funds have restrictions around such claims, said Mercer Bullard, an associate professor of law at the University of Mississippi. Mutual funds are valued on a daily basis according to regulatory requirements while hedge funds have fewer mandates on when and how to mark their assets, said Bullard, who’s also founder of the investor-advocacy group Fund Democracy.
“There could be investor confusion between which ads are for which types of products,” said Bob Grohowski, senior counsel for the ICI.
Private funds should be required to state in their advertisements that the investments are distinct from mutual funds and not appropriate for everyone, the ICI said in a May comment letter. The government should restrict performance claims and increase the $200,000 income threshold for who qualifies as an accredited investor since it was set in 1982, the trade group said. The SEC didn’t include those recommendations in its proposal.
Traditional mutual-fund companies including Vanguard Group Inc., T. Rowe Price Group Inc. and American Funds, a unit of the Capital Group Cos. directed inquiries for comment to the ICI. BlackRock and JPMorgan are also members of ICI, which has 256 member firms.
“Some of the more traditional mutual-fund managers should feel very threatened by this,” Bullard said.