What exactly is a “sophisticated” investor anyway?

Feb 21st, 2010 | Filed under: Academic Research, Featured Post, Today's Post | By:
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One of the most overused words in hedge fund sales is “sophisticated.”  If we had a nickel for every time a hedge fund marketing sheet proclaimed that a fund was for “sophisticated investors,” we’d be running a hedge fund for, well, sophisticated investors.

But what exactly does it mean to be sophisticated?  This is a question addressed by Jan de Dreu of RBS and Jacob Bikker of De Nederlandsche Bank in a study of Dutch pension plans.  The duo bases its analysis on the fair assumption that “sophisticated” means “not succumbing to behavioural finance biases.”   While many studies have examined behavioural biases in individual in private investors, they write, “much less is known about professional parties.” More…

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  1. [...] All About Alpha: What exactly is a “sophisticated” investor anyway? [...]

  2. Having run an institutional Hedge Fund, it quickly became apparent that the notion of only allowing “sophisticated” investors was really a substitute for not allowing “unsophisticated” investors. This is because the looser regulatory environment did not allow for the same levels of investor protection that could be presumably relied upon under greater regulation and oversight. That said, a common argument used be sophisticated investors when faced with a loss is estoppel. So we are sophisticated until we are wrong, in which case we relied on your “misrepresentation” (so much for the role of Due Diligence!). Lack of regulatory oversight is not congruous with the ability to abdicate ones responsibility for outcome.

    Rather than comparing the skills that constitute sophisticated vs unsophisticated, I prefer to look at the problem from the ski slope prospective. The Double Black Diamond is there to tell you that their is a reasonable chance that you won’t get down uninjured. Your choice of going their is one of your own self assessment and risk tolerance. Double Black Diamonds are the Ski resorts
    attempt at self risk regulation. The Market requirement for sophistication is equivalent to the ski resort saying ” don’t go down this double black diamond if you aren’t wearing skis and holding poles”. I don’t believe it ever implied anything more.

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