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Smart investor

Rich enough to reduce risk? Why are most people not permitted to invest with quality portfolio managers? Ancient 1930s laws make high risk long only available to anyone yet prevent Mom and Pop from accessing top talent. Why should their retirement plans rely on fund managers that don't have the brains, talent and experience to run a real hedge fund? Why "protect" retirees from the most suitable investment products? Who is REALLY being protected?

1. Freedom. How wealthy should one be to allowed to invest with top managers? The "accredited investor" amount must be REDUCED to give access to quality money management and proper portfolio diversification. Regulators are even attempting to RAISE the net worth required to invest in hedge funds! They should look at how the financial world has evolved since 1982 not simply inflation adjusting for "sophistication". Time is not money; information and innovation are money and all investors are WEALTHIER today in that regard. It's time EVERY investor was allowed to access better sources of absolute return.

2. Empowerment. Financial and technological innovation has empowered individuals of all wealth levels to make better investment decisions on a more level playing field. Investors have access to information that is vastly more comprehensive than 25 years ago. The ability to check out potential funds and managers is far superior. Back then there was no financial TV and no investment websites. No media coverage or scrutiny of hedge funds. Almost no third party evaluation and research on any fund managers. Adjusting for information and innovation there is now little need to "protect" the non-accredited investor.

3. Global financial innovation. In 1982 it was basically US stocks and US bonds for most US investors - large or small - but products and markets have evolved and almost the entire world is now investable. A much wider variety of assets and strategies are also now available but many require expertise to navigate. During the past 25 years, electronic trading and deregulation have made execution much cheaper making shorter term, higher frequency strategies feasible. Arbitrages that were not possible, due to illiquidity, high transaction costs or non-existent securities (at that time), are now tradeable. The relationships between different asset classes in different countries over different holding periods creates new money making opportunities. Why can't anyone who wants to benefit from financial technological advances in investment strategies be allowed to do so?

4. Risk management. Nowadays financial engineers have the product tools to eliminate or repackage many market exposures. In 1982 the ability to hedge out risk factors was very limited. Equity and interest rate derivatives markets were embryonic while weather, property and credit derivatives were over a decade away. The opportunity to reduce some risks and keep those you are skilled enough to take is the key financial development in the last 25 years. Why should retail investors only have available unhedged stocks and bonds? Why must the retail investment product industry ALONE stay stuck in the time warp of long only? Yes, managers with the skills to manage risk charge higher fees but should not people have the freedom to choose those funds if they want? Another word for hedge could be insurance, so why not allow retail investors to invest with managers who make an effort to insure their portfolios? Yes you CAN diversify away systemic market risk.

5. Risk tolerance. The risk continuum is cash -> bonds -> hedge funds -> long only equity. Good hedge funds are LESS risky than long only funds. However how you measure it, their VaR, or value at risk, is lower and the volatility of returns is less. The downside and drawdown risk is much lower and of course the Sharpe and Sortino ratios are far better. The performance in bear markets, in particular, is vastly superior. For the past 50 years hedge funds have outperformed long only products on a risk-adjusted basis. At least let risk-averse investors get a higher return than bonds without enduring the devastating losses and volatility of public stock indices, if they so choose. Just as some investors will prefer to remain in the hazardous stone age world of long only unhedged funds, should not others have the freedom to invest in risk managed investment products?

6. Track record. Back in 1982 stocks AND bonds had been poor investments for many years. Yet hedge fund managers like George Soros, Warren Buffett and others knocked the cover off the ball throughout the 1970s. The original accredited investor law came in 1933, yet the stock market then was lower than 30 years previously, while hedge fund managers like Jesse Livermore, Bernie Baruch and others performed outstandingly during that era. More recently better hedge funds made money in 2000, 2001 and 2002. Isn't it about time the proven ability of good hedge funds to make money in a bear market was made generally available? Isn't it logical that the mass affluent have a way to partially immunize their portfolios against 50-80% drops in the stock AND real estate markets BEFORE they do?

7. Retirement. Hedge funds in DB plans but not DC? It is inconsistent that hedge funds are deemed suitable for retail beneficiaries of defined-benefit plans but NOT defined-contribution menus. Many DB pension funds either have or are in the process of including hedge funds in their portfolios, because they recognize the return enhancing and risk reducing benefits. But today the move is to defined contribution and self-directed pensions. DC pensions infamously perform MUCH worse than DB pensions since they are not managed by a dedicated investment team, have higher fees, less diversification and no economies of scale. With DC pensions, individuals are out in the cold and their employers' bottom line is not affected. Why can't individuals, saving for their retirement, get added portfolio diversification away from long only and towards more consistently performing products. Every 401(k) menu should have, at the minimum, some good hedge fund of fund offerings. Make a portfolio of 50% bonds and 50% hedge fund of funds the default DC option. If an individual decides to gamble their retirement away on long only equity they can then choose to take that much HIGHER risk.

8. Hedge funds are NOT a threat to mutual funds. No hedge fund manager has the time, ability or inclination to build the massive sales, marketing, hand-holding and record-keeping infrastructure necessary to "go retail". Proper hedge funds focus on performance generation not asset gathering. But why should a financially smart, self-directed investor be precluded from putting some of their money, no matter how small, with their chosen hedge fund? Assuming the manager agrees, which is a big assumption given the desire for big tickets these days, what rationale does the SEC have for preventing consenting adults from doing this? Some retail investors would prefer to put their money with hunter gatherers rather than asset gatherers. Hunters are incentivized to perform successfully, otherwise they starve.

9. Complexity. Hedge funds are sophisticated and the instruments many of them trade require specialist expertise. Cannot all investors be permitted to access and pay for this skill? Retail investors should be allowed to properly diversify their portfolios with new, lower risk sources of return. The SEC assumes a negative net worth "natural person" who wins the lottery suddenly becomes an investment expert. Finance is complicated but so is surgery or flying a plane. Why do people have the freedom to find a good doctor or good pilot but not a good money manager? Also retail investors in many other countries are allowed to choose between long only funds and hedge funds, that compete side by side in a free market. The SEC could learn a lot from overseas regulators. Australians and Japanese can easily buy retail hedge funds. French retail investors pick them up with their groceries at le supermarché.

10. Administration. Hedge fund scandals have primarily been confined to the USA. The SEC could require ALL onshore US-domiciled funds to have INDEPENDENT administration and valuation. Almost all frauds can either be traced to fudging the valuation of securities or managers having total control of fund cashflows. In the offshore world, wire transfers from investors go to a NEUTRAL fund administrator and I don't see why this could not happen with ALL onshore funds. It is a safer check and balance for institutional, high net worth AND retail investors.

Fund manager selection does indeed require sophistication, but that applies to ALL strategies including long only. Unless an individual, of any wealth level, has the time and expertise to pick hedge and traditional funds themselves, they need INFORMED advice from those with the skills to conduct thorough analytical due diligence on managers and construct a TRULY diversified portfolio. The accredited investor rule has never justified the division of individual investors into "sophisticated" and "non-sophisticated", based on such a blunt measure as net worth.

Individuals are now responsible for their own pension investment decisions. Isn't it about time those who choose to were allowed to diversify return sources and reduce equity market dependence? Let's hope they don't have to wait until 2032. "Blogs are a great way to infer passion and depth of feeling" said Christopher Cox, SEC chairman, recently. He can read an overwhelming vote AGAINST restricting hedge fund investments to "smart" investors at the SEC website. The SEC is receiving hedge fund regulation comments.

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