If you have significantly long experience in the financial market, perhaps it is time you considered how to start a hedge fund. Do you look forward to the thrill of investing in financial markets; does the jingle of profit make you dizzy with happiness? Then I am sure starting a hedge fund will help you combine your passion with a viable business opportunity.
Starting a hedge fund is as much about creating a profitable proposition for your investors as it is about creating a phenomenal investment channel satisfying your need to start your unique financial solution.
Steps to Start a Hedge Fund
Here is the list of the steps you have to complete to start your own hedge fund company:
- Capital Is Primary for Starting a Hedge Fund
- Understand the Basics of Starting a Hedge Fund
- How Are Hedge Funds Different from Mutual Funds
- Selecting the Right Strategy Important While Starting a Hedge Fund
- Decide on the Fund Type
- Create a Team of Advisors
- Create a Fund Name
- Apply for the Tax ID
- Register Company as Investment Advisor
- Creating Corporate Bylaws
- Creating the Offer Document
- Promoting the Hedge Fund
1. Capital Is Primary for Starting a Hedge Fund
Starting a hedge fund is a multi-pronged process. You will need to start your own fund, register it and then take it forward as a private investment. Securing the required amount of capital is often the first step in how to start your own hedge fund. You must remember that if you are not able to arrange for the adequate amount of fund, the other steps don’t matter at all. Incidentally, arranging for funds is rather tricky and often new funds find maximum resistance at this level. I must mention that experience here does not count too much.
Even if you are a very experienced and seasoned fund manager with a consistent track record of success, starting a hedge fund is never easy. You have to make sure that you are able to convince people to do business with you. Therefore securing capital is one of the biggest uncertainties as you explore how to start your own hedge fund.
It is almost like the ignition of your car.
It doesn’t matter how fancy a car you have if you are not able to switch it on and drive it around. In many ways, the starting capital provides that crucial ignition for starting a hedge fund. If you are not able to manage this, the hedge fund can fall apart like a pack of cards. The starting capital often creates a gateway to success for you. Not only does it open up several channels of communication, but it also provides the fundamental push to take the hedge fund forward. In many ways, it is the foundation stone for a sustainable business model and helps you understand how to start a hedge fund. With the right capital in hand, you will get the confidence for starting a hedge fund and take forward your consistency and proven track record as a fund manager.
Though hedge funds have seen significant negative publicity in recent times after the recent collapse in the financial markets, they are still an exceptionally profitable proposition. Remember that there is never a dearth of investors looking to expand their profit margins, net worth and overall investment kitty. That, in many ways, becomes your chance to capitalize upon and take steps towards starting a hedge fund. While there is never any dearth of opportunities, you have to explore the options about how to start a hedge fund to match this demand. But you have to understand that before anything, you must make sure that you have the requisite capital in place.
2. Understand the Basics of How to Start a Hedge Fund
Once you have the capital in place, the next step towards starting a hedge fund is undeniably learning the basics of business. You could be a great fund manager, but at the same time, managing your own hedge fund can be an entirely different ball. Hedge fund is essentially a pool of money that uses a combination of multiple strategies to generate above average market returns. It helps investors to both create returns and manage risk simultaneously. But you must remember when you are starting a hedge fund that only accredited investors can invest large sums of money in it, anywhere above $1 million.
As you all know, hedge fund originates from the word, hedging the risk. This essentially means reducing the risk exposure of a given investment. The diversified investment is so designed that the downward risk in the price movement does not materially impact the overall returns from the given fund. In fact, to achieve these gains, hedge funds at times use a complicated range of strategies that protect the downside and also maximize the overall return prospects. So when you are looking out for information on how to start a hedge fund, various elements of the investment using stocks, currencies and economic trends need to be taken into consideration. It does not just diversify the overall investment, but in many ways, it helps you to lock the extent of returns that you would like to preserve.
3. How Are Hedge Funds Different from Mutual Funds
As you prepare the fundamentals of how to start your own hedge fund, you have to pay careful attention to the differences between the various mutual funds and the hedge fund that you are creating. So how exactly is your hedge fund different from the various mutual funds that are already available?
Most importantly, hedge funds are managed and invested in by a more sophisticated set of investors. That means that while both mutual funds and hedge funds are pools of money that are managed by different fund managers, you have to understand that relatively deep-pocketed and more serious and suave money market players invest in hedge funds. Unlike mutual funds, hedge funds are never regulated as closely by the SEC. They, as a result, can, therefore, invest in a lot more diverse investment opportunities. The relative risk profile is also far greater in the case of hedge funds.
The relative leverage in hedge funds is also significantly higher. There are more options like short selling and long-short equity combinations to reduce the relative downside in the market. While mutual funds are registered publicly and are approved by the SEC, the Hedge Funds are generally funded through the private placement route. With the overall net worth of most hedge funds well over $1 million, the relative return scope is also much higher. Compared to Mutual Funds, Hedge funds are significantly more illiquid in comparison. They are typically locked in for a relatively longer period of time.
Another significant difference that you must keep in when you are starting a hedge fund, is the compensation level. In fact, the level of compensation for Mutual Fund managers is very different from hedge fund managers. Typically hedge fund managers receive compensation in 2-20 ratio. This comprises 2% of the total assets as well as 20% of the profit percentage.
4. Selecting the Right Strategy Important While Starting a Hedge Fund
While looking at the various aspects of how to start a hedge fund, it becomes immensely important to select the right strategy. Hedge Fund managers are primarily famous for the kind of returns that they can help their investors earn. It is needless to mention that these returns are directly proportional to the success of the strategy that they can implement. When a hedge fund manager with a track record of continuous success and relatively strong gains plans on starting a hedge fund, the relative response to it will be significantly higher. Investors are fairly sure about the kind of returns that they can hope to earn if a specific person is selecting the investment strategy. So when you are trying to understand how to start a hedge fund, here is a list of some of the best known and most common strategies that you can look at implementing:
– Neutral Strategy
As the name suggests, this is a strategy that helps you keep a neutral bias in the market. This is a rather popular strategy. In this, you buy a certain set of investment options that are likely to go up. Now you offset the impact of this by consciously short-selling the market. Now let’s say that the gains from the investment that was supposed to go up fared a lot better than the portion that you short sold. The direct result would be that on an overall basis the fund would be in the money. For investors who are worried about market crashes, this would come out to be a rather interesting strategy that can keep their gains assured over a sustained period.
– Hedged Equity Strategy
In essence, this strategy too has similarities to the above-mentioned market neutral strategy. However, in this case, the entire portfolio is not shorted. The shorting happens only on a select portion. The direct advantage of this is if there was a collapse in the market at any point, the investor’s downside remains protected. At the same time, every gain in the market would significantly add to the gains in the portfolio. In other words, this is a strategy where you gain more when the market rises, but your loss in case of a collapse is somewhat limited.
– Global Macro
As the name suggests, this strategy is closely linked to the macro factors affecting global markets. This is a rather effective strategy for fund managers who have a deep understanding of the various global factors, the economic parameters and top trends prevalent on a global basis. The trick that they use to make money depends entirely on how they can read global developments. They spread out and invest the fund in a specific manner depending on how the global events would unfold in a specific case or for a specific country. So the essential gains or losses of the fund are dependent on the actual criterion or circumstances that unfold in the global perspective.
– Undertaking the Legal Proceedings
Deciding on how to start your own hedge fund involves a lot of other formalities as well. Once you are through with the basic conceptualization and creating of the broad strategies of your fund, the next step is deciding on the core formalities and getting the fund up and running. Therefore, it is needless to mention that the next key point of focus is undertaking the legal formalities to get the ship moving.
– Hiring a Legal Firm
The first and foremost step in this direction would be hiring a law firm to take the paperwork ahead. It is almost an unsaid rule that you should establish contact with a group of experienced lawyers in the financial sector. They should be well versed with all the regulation in the financial sector, and as a result, in constructive and pointed results. This would mean that you would not waste time or money in unnecessary paperwork, but at the same time, all your legal formalities would be in place. When you plan on starting a hedge fund, it is always better to go for an experienced and well-versed lawyer with Hedge Fund formalities and legislations.
5. Decide on the Fund Type
Every aspect of planning for starting a hedge fund is necessary. Therefore, getting the fund type right is also important. However, this will depend on the specific laws with respect to your state. Be it limited partnerships, trust or whichever type of hedge fund variant that you would like to create; it is important to undertake detailed research in this context. Contacting the state specific commerce department is extremely important to get the regulation details. This will help you understand the relevant guidelines for complete details. In case you decide to opt for a limited partnership for your hedge fund, it is important to realize that there are two parts to it. It will either be a general partner who acts as the business manager and is liable for all loans or corporations. In the case of corporations, they become the general partner.
In this case, the limited partners, however, are not liable for any loans undertaken by the company. A firm decision on the fund type can go a long way in influencing the overall investment strategy and operational dynamics of the hedge fund that you are planning to start. It also eases out the regulatory formalities associated with the hedge fund.
6. Create a Team of Advisors
Planning and preparation of how to start a hedge fund invariably need to include a team of trusted advisors. Remember the success of any hedge fund invariably depends on the quality of the team that you put together. Remember it is rather difficult to sell the hedge fund to investors without creating a substantial track record of success. This is exactly where a team of trusted and experienced advisors can make all the difference. While the hedge fund might be new, there is absolutely no doubt that the credibility of the team can go a long way in establishing a distinctive identity for the hedge fund.
Additionally, the team of advisors that you select also needs to be dynamic personalities. Their interpersonal relations, vision about the future and passion in the present plays a key part in furthering the business prospects in a comprehensive manner.
7. Create a Fund Name
Think about the time you named your child. The tribulation and turmoil that you went through in selecting the most appropriate name. Well, starting a hedge fund is no less momentous. So be very careful about naming the hedge fund that you are creating. Think about a name that is catchy, sounds dependable, extremely stable. It should be a serious and reputable name that will sound convincing to your investors. Additionally, the name would also need to promote the image of the concept that you are creating. In the context, it is always important to connect the name to the core investment strategy of your hedge fund. In many ways, the name of the hedge fund should take forward the vision that the hedge fund was conceptualized with.
8. Apply for the Tax ID
In a stepwise progression and preparation of how to start a hedge fund, the next step involves applying for the tax ID number. According to the US regulation, you need the Federal Employer Identification Number from the US Revenue Department, Only then can you begin operations seamlessly. Applying to the IRS is no big deal either. You can easily fill the form online on the IRS website. You don’t have to pay anything to get this ID number either, and the process takes barely a few minutes. Getting this number is not just important from the regulation perspective, but it is also relevant in lending better credibility to your business model and attracting more investors.
9. Register Company as Investment Advisor
The next step in your plans for how to start a hedge fund is another regulatory formality. You have to register your company with the US Securities Exchange Commission as an investment advisor. However, the precondition is that you need to have at least 15 investors associated with the fund. According to the law of the land, all potential advisers also have to apply for Uniform Investment Adviser Law Examination. A basic three-hour test, it probes your understanding and basic knowledge of the various securities laws and their implementation in the Hedge Fund market.
– A Corporate Partner
When you are starting a hedge fund, there are two ways you can structure a fund. You can either be the sole proprietor of the hedge fund that you have created or create a corporate partner. Of course, when you make a corporation with your partner, you reduce your own liability to a large extent. In this context, you must remember that in limited partnerships, all obligations of the business and liabilities are with the general partner. However, in the case of a corporate partner, your personal assets are saved if there is ever a legal dispute on any matter. The corporation becomes the legal entity responsible for the business. However, this process should be completed in the presence of a lawyer ad completely with legal guidance. Creating the separate identity gives the hedge fund relatively greater credibility and a better leeway to deal with the legal complexities. Creating the separate entity also results in a relatively smooth functioning of the entire operational matrix of the hedge fund.
10. Creating Corporate Bylaws
The process involved in how to start a hedge fund is never simple. There are innumerable formalities associated with it. Your firm has to work on compiling a unique set of in-house rulebook to move forward. Some of the most commonly used by-laws include:
- Compliance Manual
- Ethics and code of conduct
- List of supervisory norms
- Portfolio agreement
11. Creating the Offer Document
One of the basics of how to start a hedge fund is undeniably being able to sell it to your investors in a convincing manner. One of the simplest ways to attracting investors to your hedge fund is by creating a set of document that clearly spells out the various rules, regulation and vision of the fund. It clearly states the goals of the investment and can often be considered the prospectus of investment tool. In many ways, we can consider the prospectus as the key document that protects the hedge fund too. This is because it clearly states the terms and conditions of operations.
It also states the liabilities and losses of investors in very clear terms. Additionally, it gives details of the various strategies that would be implemented by the hedge fund. Therefore, there is no scope for ambiguity and the hedge fund is literally an open book to its investors. However, this memorandum or prospectus is not an option for the hedge fund. The regulatory body makes it a mandatory provision, and it is important to make sure all necessary disclosures are made.
12. Promoting the Hedge Fund
Last but not the least important, when you are looking to explore options about how to start hedge fund on your own, you need to actively promote the hedge fund. This is the only sustainable way to generate capital and take forward the concept. So as we draw to almost the last step in how to start a hedge fund, we kind of harp on the most important and first step of the whole process. In short, promotion is as important to starting a hedge fund as generating capital for it. In many ways, seeking capital and promoting a hedge fund operate in a symbiotic fashion.
Promotion often is the most refined form of salesmanship to create the necessary eyeballs to garner that interest amongst the investors who would eventually pump in the money necessary to sustain the hedge fund. Your promotion campaign normally focuses on some key factors:
- The key factors contributing to your success
- The reason why your hedge fund offers superior opportunities
- The return target and potential offered by your hedge fund strategies.
In short, your promotion campaign is all about bringing in maximum value to your hedge fund execution implementation and final potential. The idea is to create sustainable value over the long-term ad take it forward to the end users eventually.
As the old saying goes, nothing attracts success like success itself.
When investors get to know of the track record, the average success rate of your fund and the talent and expertise of the partners and employees that your firm recruits, they will be more convinced about your venture. You can even offer incentives to your investors in the initial phase. However, you must keep in mind that you are not breaking any regulation guideline in the process of offering marketing incentives to your investors. This will serve a dual purpose. While on the one hand, you are more prone to win over your customers and potential investors through the incentives, you can be sure of not rubbing the legal administrators the wrong way in any possible manner. Try and use the online channels for active promotion of your hedge fund.
The biggest advantage is that you can be rather dynamic with your promotion plan. The online presence will give you more flexibility, and more and more people get to know the product that you have created. We mentioned how sometimes more than the product, it is the person who created the hedge fund which attracts more attention. Sometimes, the product might be new, but investors have trusted a specific fund manager for years, and often the above average response seen by many new hedge funds represents this fact quite appropriately.
Therefore, we can conclude that the process involved in to start your own hedge fund is systematic and methodical. Of course, you might find it rather painstaking to proceed in such a step by step manner, but the fact remains that it helps in creating meaningful gains. The sustained recalibration of the investment rationale and objectives make sure that customer interest is never compromised with. Raising capital, promoting the products and providing the marketing team with the promotional material form the three main pillars to take forward the investment module in a constructive manner. Starting a hedge fund often needs sustained patience, diligence and absolute precision.
Investors need to have a clear picture of the vision and financial goals of the hedge fund. This single-handedly makes sure that maximum possible interest is garnered for the new and successful investors as well as seasoned veterans. This improves both the return potential as well as the reach of the visa department.