SEC to watch hedge funds that beat the market

Marketplace Staff Mar 29, 2011

SEC to watch hedge funds that beat the market

Marketplace Staff Mar 29, 2011

Kai Ryssdal: The Securities and Exchange Commission has been trying to get its hands on hedge funds for years, bring them inside the regulated world that most other traders and markets have to live in. That hasn’t worked out so well, so the SEC’s trying something different.

Regulators have now decided they’re going to poke through the profits that hedge funds return to their clients. The rule of thumb is that any fund that beats the market by more than 3 percent is fair game.

We’ve got our New York bureau chief Heidi Moore on the line. Hey Heidi.

Heidi Moore: Hi Kai.

Ryssdal: So why is the SEC looking into this now?

Moore: Two words: Bernie Madoff. So Bernie Madoff, as you know, had incredibly good returns the whole time that he was investing over decades. He only had three or four bad months. And of course, that’s nearly impossible to accomplish. Someone who’s honest probably won’t do so well so regularly. Now the problem is that the SEC can’t really look into hedge funds — in fact, they have this relationship a little bit like what you saw in “Seinfeld”: ‘Hello, Newman.’ It’s always been somewhat combative. So the SEC may not have the manpower or the access to find out this information. They’re going to have to check public databases just like everybody else.

Ryssdal: And we should point out that’s because hedge funds are largely unregulated, right?

Moore: Exactly. They have fought every attempt at regulation and in fact, they don’t even have to file their addresses with the SEC right now. Although, they will eventually.

Ryssdal: So hedge fund managers clearly not happy with the prospect of the SEC looking into their rate of return. But objectively, if you can, what’s so wrong with it?

Moore: Well, the biggest problem is that hedge funds actually are supposed to beat the market a lot. So I asked a hedge fund manager, Eric Jackson at Ironfire Capital, what he thought.

Eric Jackson: If the bar is 3 percent, it just seems like such a low bar. A typical investor expects a 7 percent return in stocks. I think most investors going into hedge funds expect better.

Moore: So most investors think that Bernie Madoff was pretty unique. And profits, or returns, are sacrosanct to hedge fund managers. They don’t want anyone looking too closely. They’d prefer the SEC to just answer the calls that come into their office, the complaints, and they think that’s the better way to find wrongdoers.

Ryssdal: Yeah, of course they do. I mean, that kind of makes sense if you’re a hedge fund manager. But draw the larger lesson for me: What does this — first of all, the fact that the SEC is looking into it, and then the hedge funds’ reaction — what does this tell us about the larger hedge fund industry?

Moore: Well it tells us that hedge funds probably have to be a little bit more clever. Back in the day, to be a hedge fund manager, you had to be a rebel. You had to be somebody with a great idea that nobody else had, and you could invest it. Every hedge fund has a recipe a little bit like New Coke for how they make their money. They never really reveal what it is. So now, hedge funds are these big public companies in some cases, and they’re completely respectable, and there are a lot more of them. So it’s very hard to get that good idea, that New Coke recipe, that nobody else has. And I think that we’re looking right now at an industry where they have to distinguish themselves.

Ryssdal: And let’s make one larger point: it’s not just rich people in hedge funds anymore. It’s pensions funds and all kinds of other things.

Moore: That’s right. Hedge funds are huge players in the markets, and most regular people never see them and never hear of them. But they’re the ones who move money around, between the investment banks, pension funds, colleges. They’re a big part of this economy.

Ryssdal: Our New York bureau chief Heidi Moore on the SEC looking into hedge fund returns. Heidi, thanks a lot.

Moore: Thank you Kai.

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