Hedge funds: Little guys need not apply

One door closes, and a window opens.

Last month the Securities and Exchange Commission proposed raising the required minimum of investable assets of individuals purchasing new hedge fund investments from $1 million to $2.5 million. Ostensibly, the move protects small investors from the volatility of hedge funds by blocking their entry altogether. Declared SEC commissioner Paul Atkins, "These investments are meant to be reserved for people who are wealthy enough to seek the investment help they need."

Ah, but Mom and Pop can take heart: The stock market is beckoning as another avenue into U.S. hedge fund investing. In November, Fortress Investment Group, a New York­based alternative-investment operation with nearly $30 billion in assets under management (including hedge funds), filed a registration statement with the SEC ahead of a planned initial public offering on the New York Stock Exchange. No date has been set for the IPO, but signs point to Fortress's becoming the first hedge fund to go public in the U.S. Several asset managers are listed on the London Stock Exchange, including Man Group, whose shares have risen more than fivefold since its IPO in February 1994, and RAB Capital, up 74 percent since its March 2004 IPO.

But Fortress is not aiming to court small investors. Like many of its peers, the firm would prefer to manage big chunks of pension fund money, says Eric Weber, a consultant at Freeman & Co., a New York M&A advisory firm that serves hedge funds and other financial institutions. Fortress figures that submitting to the rigorous disclosure requirements for any publicly traded traditional money manager "shows big institutional investors that the firm is not just serious about running their money. It is serious about running the firm," says Weber.

Fortress and Goldman Sachs, the firm's lead underwriter, declined to comment, but a December 21 SEC filing says the firm plans to use $250 million of the IPO proceeds to repay debt and the remainder for general business purposes. The filing also describes a new relationship with Nomura Holdings of Japan, which announced in December that it would buy a 15 percent stake in Fortress for $888 million. That would value the firm at about $5.9 billion.

For most hedge fund managers, the challenge of the proposed SEC change will be attracting customers from a smaller pool. The SEC determined the $2.5 million net worth benchmark (the minimum household income standard of $200,000 will not change) by factoring in inflation and the exponential increase in real estate values since 1982, when the $1 million entry limit was imposed. At that time, only 1.9 percent of U.S. households would have met the regulator's requirements. In 2006 an estimated 8.5 percent of households fell into the $1 million-plus category. If the higher threshold is approved, as is likely, the number of qualifying households will shrink to just 1.3 percent, according to the SEC.

That could lead to a great deal more tapping at the window.