The FSA's decision to consult with the industry over plans to market hedge funds directly to the public has ignited the debate over whether long/ short funds are suitable for retail investors.
Hedge fund providers have welcomed the regulator's proposals to widen the ways in which investors can access the funds but some of the biggest investment houses are concerned about the potential fallout from such a move.
Fidelity says that whatever the outcome of the FSA's consultation – which proposes allowing hedge funds to be listed on the UK stockmarket – it has no plans to offer them to retail investors.
Managing director Richard Wastcoat says: “We have doubts as to the suitability of hedge funds for retail investors and until they become more transparent and better understood, we do not see a place for them within our fund range.”
Fidelity's concerns are shared by many other fund managers, which say that the industry has enough problems to contend with without the potential for another misbuying/misselling scandal.
The fear is that as hedge funds are not the easiest of products to understand, it would be all too easy for investors and IFAs to get themselves into trouble. It is a view shared among many advisers.
Chartwell director Patrick Connolly says: “The FSA is being positive with its proposals but the big issue remains the same – the vast majority of IFAs do not understand hedge funds and nor do most investors. The other problem is that hedge funds are seen as fairly risky.
“Providers make out they are safe but investors cannot get past the hedge fund tag or the fact that they associate them with £100,000 minimum investment levels when they have only got their£7,000 Isa allowance.”
Nevertheless, Connolly says he would be more interested in hedge funds – and would ensure that there were specialist advisers at Chartwell – if there was a marked inc-rease in demand for them. But he says that kind of seismic shift is highly unlikely to happen for years, assuming that the FSA gets enough positive feedback from the industry to consider implementing its proposals.
Whether the FSA gets that feedback is unclear. Many fund managers are ambivalent about the regulator's plans and there is a band of big IFAs which strongly disagrees with Connolly's assessment.
Bates Investment head of research James Dalby says: “The FSA is right to consider widening access to hedge funds because investors should have the most diversified portfolios possible. As for IFAs, hedge funds are the untapped asset class. They represent an important commercial area but only regulation would give them the credibility they currently lack. People need to be given that confidence in them.”
Dalby believes that hedge funds will eventually be brought under the FSA's remit but does not expect regulation to happen in the foreseeable future.
In the meantime, hedge fund providers are embarking on an educational blitz to persuade investors and IFAs that their funds are not as risk-laden as they are perceived.
Matrix Money Management sales director Alan Sinstead says: “It is up to us and anyone else with a retail offering to try and demystify hedge funds. We need to get the message across that they are simply designed to preserve capital in times of volatility and add gentle and useful gains for investors. Why should investors be denied access to them? The big question is whether IFAs want to deal with them.”
Sinstead says many of the IFAs he has dealt with have little idea about how hedge funds work, in some cases, simply assuming that short selling means investing for short-term gains.
He hopes this lack of knowledge will improve now that the FSA has entered the debate but there is little doubt that this kind of ignorance will take some time to overcome.
One investment house which has been keen to welcome the FSA's proposals, however, is New Star. Never a company to shun a commercial opportunity, it says it would be interested in offering a hedge fund range if the FSA opens up the market.
But along with Matrix and other hedge fund providers, it does not believe that the regulator has gone far enough although it acknowledges the educational hurdles facing the industry.
Corporate finance director Ravi Anand says: “The FSA ought to be considering more detail. Sophisticated investors can access hedge funds but IFAs find it difficult to establish the good from the bad. It is a step forward but it is slower progress than we would have hoped.”
The FSA has been keener than usual to make clear its proposals are not set in stone, saying that it is coming into the hedge fund debate with an open mind. The proposals do not seem as definitive as they often are. The FSA is simply posing the question of whether hedge funds are a suitable product to increase the choice to investors.
However, by not giving the industry much either to back or rail against, the deb-ate is in danger of remaining static at a time when investment companies need a story to tell to investors.
But as long as so many fund managers and IFAs remain sceptical of hedge funds, the FSA's proposals may be at best peripheral to the retail market, whether they are implemented or not.