The Growing Demand for Registered Funds
The opportunities for hedge fund managers to grow assets under management continue to expand as pension fund, endowment, foundation, insurance and individual investors increase their allocation to alternative investments. To meet investor demand for absolute returns and diversification, as well as greater liquidity and transparency, an increasing number of hedge fund managers are offering hedge fund strategies through funds registered under the Investment Company Act of 1940 (’40 Act).
What Are the Benefits of Managing a Registered Fund?
Unregistered funds are only permitted to have up to 100 or 499 investors and require most fund investors to be accredited or qualified investors (as mandated by Section 3(c)(1) and Section 3(c)(7) of the ’40 Act). Funds registered under the ’40 Act can accept an unlimited number of accredited investors or qualified investors, which allows funds to lower account minimums and appeal to more investors. Additionally, funds registered as opened-end investment companies under the ’40 Act (or mutual funds) can be marketed and sold to an unlimited number of institutional and individual investors regardless of their income or net worth.
Why Do Investors Prefer Registered Funds?
In addition to providing portfolio transparency and greater liquidity (i.e., a mutual fund’s NAV is required to be calculated and marked to market daily), a ’40 Act registered fund provides greater regulatory safeguards. The ’40 Act requires oversight and accountability by independent fund board members; protects the physical integrity of fund assets; guards against conflicts of interest, including problematic affiliated transactions; protects against potentially unsound capital structures by imposing certain investment restrictions; and ensures that investors receive accurate and appropriate information about the fund and its manager(s). Generally, investors can also conduct due diligence and make investments in registered funds more efficiently and cost-effectively than unregistered funds. Most registered funds can be bought and sold directly from the fund and through intermediaries such as brokers or fund supermarkets (i.e., Schwab and Fidelity).
How are Hedge Fund Strategies Offered Through Registered Funds?
The evolution of fund structures has significantly broadened distribution channels for hedge fund strategies. Below are seven of the most common ways to offer hedge fund strategies through registered funds:
1. Register a new stand-alone fund (or a series trust to launch multiple funds).
2. Register a new series (or fund) of a third-party sponsored series trust.
3. Convert an existing private fund into a registered fund (or a series a of a third-party sponsored series trust).
4. Register a fund of funds (underlying funds can be private, registered or both).
5. Advise a private underlying fund of a registered fund of funds.
6. Advise a registered underlying fund of a registered fund of funds.
7. Provide sub-advisory services to a registered multi-manager fund.
Conclusion
Investors are increasingly seeking absolute returns to diversify their portfolios, as well as more protective fund structures. Investor demand for these attributes combined with fund managers’ desire to grow their AUM has driven the emergence of different ways to offer hedge fund strategies through registered funds. Although the process and cost significantly varies, hedge fund managers can easily assess the options outlined above with the assistance of a seasoned ’40 Act attorney and other fund service providers.
For more information regarding ’40 Act registered funds, please see the SEC’s Investment Company Registration and Regulation Package or contact Aisha Hunt, a Partner and the head of the ’40 Act/ Alternative Mutual Fund Practice at Cole-Frieman & Mallon LLP. Aisha can be reached directly at 415-762-2854.
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Cole-Frieman & Mallon LLP is a premier boutique investment management law firm, providing top-tier, responsive and cost-effective legal solutions for financial services matters. Headquartered in San Francisco, Cole-Frieman & Mallon LLP has an international practice that services both start-up investment managers, as well as established investment management firms.