By law, a hedge fund needs to avoid having too many (100) accredited investors in order to avoid coming under additional regulations. An accredited investor can include a pension fund, a bank, a hedge fund of funds, someone with a million dollars, and other rich persons. An investment company can also act as an accredited investor. However, people who make less than 200k dollars in either of the past two years are not accredited investors and therefore cannot invest in hedge funds. Also, a fund may require a large initial investment that more marginal investors cannot invest in. Furthermore, some of the better funds are hard to invest in, even for large investors. And I'll add in the fact that fund of funds charge an additional layer of fees that are pretty absurd.
So I think if it is legal, there should be structures like a closed end fund that solely invests in a particular hedge fund marketed to these marginal investors in hedge funds. The ideal organization to launch something like this would be an already respected fund of funds, a global investment bank, or some other organization with many contacts among large hedge funds. You could start with like the five or ten largest hedge funds that are open to investors and then expand into more.
Again it would be best sold to the marginal hedge fund investors. Someone with a 500,000+ portfolio and willing to invest 50k in a hedge fund might be willing to do it if they can buy in with a share in a closed end fund that is investing many millions more in a fund. Seems like a winning idea to me, if it's legal and the organization behind it has the relationships.
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The first objection that I can think of, from a hedge fund's point of view, is that a closed end fund would have to make all kinds of disclosures to the SEC. Maybe even a full 10-K, with holdings, strategy, etc. Now, a lot of this would be available through 13-Fs, but those have a bigger delay.
I think there are also requirements for mutual funds like custodians which would have difficulty with holding shares in a mutual fund, especially if it were offshore.
I imagine hedge funds themselves would be unwilling, since their lawyers continually exhort them not to do anything that might be construed as marketing to non-QIBs.
Disclosures to the SEC are certainly going to be an issue. However, if you had like a one hedge fund for one closed end fund, you could just say 100% interest in hedge fund x. I'm obviously not a lawyer, so I'm not sure you could just copy/paste their 13-f or how that would work. I think that some clever financier would be able to create a structure that is marketable to more investors than the typical fund and avoids some of the disclosure issues. Personally, I would find it satisfactory to say this fund has a 100% investment in hedge fund x and then provide whatever documents are available from that fund. Since I'm not a lawyer, I'm not sure that's legal.
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