Hedge Funds Are Often Offered Under SEC Regulation D
Creating a publicly traded investment structure can be incredibly expensive, time consuming, and difficult because hedge funds are often structured as limited partnerships, they are considered "securities". The rules are complex and almost prohibitive for small time money managers who just want to pick stocks. The Securities and Exchange Commission, or SEC, allows a way around this by exempting several different types of pooled investment vehicles from registration requirements. Most of these exemptions, but not all, are found in something known as “Regulation D”. It is here, in Regulation D that you discover why it is so difficult for new investors to buy into hedge funds.
The Top Reasons It Is Difficult for New Investors To Buy Into Hedge Funds
Reason #1: Hedge Fund Opportunities Are Limited
Specifically, there are three very important parts of Regulation D … Rule 504, Rule 505, and Rule 506. These three rules each have different benefits and drawbacks but the common denominator is that they allow a company or hedge fund to raise money from investors without filing a lot of paperwork. Common restrictions are the inability to raise money from more than 35 non-accredited investors or raising no more than $5 million in any 12-month period. (For more information, read What Is an Accredited Investor?.
Reason #2: Hedge Funds Are Not Allowed to Advertise
Furthermore, Regulation D Rule 504, 505, and 506 generally ban advertising, making it nearly impossibly for you to learn about hedge fund opportunities unless you have an existing relationship with an affiliated broker-dealer. This provision is meant to protect investors but some business publishers have argued that it is now outdated.
Reason #3: Hedge Fund General Partners Can Admit Who They Want
Hedge fund general partners, the people running the portfolio, can accept or reject who they want without cause or reason. It isn't like investing in mutual funds or investing in stock where anyone who can afford to buy shares is entitled to do so. It is important when dealing with a private placement security, such as a limited partnership interest, that everyone has the same investing philosophy.
Reason #4: You May Not Meet the Minimum Investment Requirement for the Hedge Fund
The minimum investment for a hedge fund can be almost anything the general partner requires. Since there is a limit to the total number of investors that can be admitted under a Regulation D Rule 504, 505, or 506 exemption, they are going to want to make that figure high. Some hedge funds require a minimum investment of $100,000, while others may require $25 million!
Don't Forget: Hedge Funds Are a Generic Term and Impossible to Classify
When someone says they bought a “hedge fund”, it doesn’t really tell you anything. A hedge fund isn’t necessarily a good investment anymore than a stock can be good or bad. It is merely a descriptive term that tells you that you are dealing with some sort of pooled investment fund that is probably not registered with the SEC because it falls under one of the Regulation D exemptions. You could have a hedge fund that specialized in buying and selling hotels, one that bought stocks on a value investing basis, one that traded fine art, or one that bought and sold rare stuffed animals!When Warren Buffett started his investment partnership in the 1950’s in Omaha, he really was running a lightly regulated hedge fund with his family and friends as the first investors. If you didn’t know Buffett or someone close to him, you would have never heard about his partnership. It wouldn’t have appeared in the pages of your local newspaper and wouldn’t be available through your local stockbroker.
