A hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk. Hedge fund strategies vary enormously — many hedge against downturns in the markets — especially important today with volatility and anticipation of corrections in overheated stock markets. The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.
Legally forming a hedge fund if is a bit more difficult than forming a corporation or LLC for a private business. It involves a lot of navigation of various investment compliance laws, and you could get in trouble if you don’t seek professional help along the way. The laws surrounding and governing your business change entirely based on what country and state you are in. They also may be drastically different based on where geographically you are seeking investors, how you are contacting new investor leads, what you are investing in and how many investors you are working with in total.
Becoming the manager of your own hedge fund will give you the opportunity to invest other people’s money for them, which can be profitable for you and your investors. If you’re an experienced financial advisor, it may be advantageous for you to step out from under the umbrella of the banking industry and strike your own path. To start a hedge fund, you’ll need to create and register a fund and start an investment company to be the fund’s general partner. In this endeavor, the investors will act as limited partners in a corporation. Below are few more important points to know before you start a Hedge Fund.
● Know the difference between Hedge Funds and Mutual Funds
There is only one similarity that both Hedge funds and Mutual funds are both pools of money are managed by a fund managers. Rest there are several differences between the two important to know the differences before starting one.
Firstly both Hedge funds and Mutual funds have different levels of accessibility. Mutual funds can be purchased by almost anyone while in the case of Hedge funds you need to be an accredited investor for which there are certain criteria you need to fulfill as per various government norms in different countries.
Secondly the regulations applied to mutual funds does not apply as much to hedge funds. Hedge funds can venture into a lot more risky and diverse investment which is not possible in case of mutual funds. Hedge funds can perform short selling, can use large amount of leverage and also make risky trades on behalf of their investors which is not possible in mutual funds.
Finally hedge fund investors have a certain lock in period of investment during which they cannot sell their shares while mutual funds investors can sell their shares whenever they want.
● Getting the Law On Your Side – Hire a Law firm
The first step would be to hire an experienced hedge fund attorney. This would be the most expensive option, and for many hedge funds it means that they have less capital available to recruit experienced team members or invest in software. Don’t be mistaken by those who say you only need a small amount of money to get everything in place and start a hedge fund, as many funds spend over $1 million in their early stages. Others may start a fund with only $10,000, but the point is that there is always another team member to recruit, resource to obtain or capital raising expert who can help you get to the next level to hire. As a reference point, most hedge fund managers start their businesses with $15,000-50,000. Of course, there are plenty of exceptions who spend up to $350,000 in startup costs. Look around for lawyers that are experienced in financial law, and even better, lawyers that have experience specifically working with and starting hedge funds.
● Design a good Hedge Fund Strategy
Designing and planning a strategy for your Hedge fund is of uttermost importance. One has to have a prior plan and vision of how to go about investing the investors money which would reap great returns for the investors. Basic steps to be followed as follows.
Firstly the Hedge fund manager must prepare a detailed business plan so he/she can calculate what the initial establishment costs are for the Investment Manager, two years operating costs and repeat the exercise for the Fund. That will establish the minimum capital needed, before he can expect and revenue from investors.
Secondly identify service providers and advisors, including an Attorney, Auditor, PB, Administrator and Payment Bank.
Draft documentation, which must be complete and absolutely accurate and must cover all possible situations. These documents, which will be drafted by the Attorney, will include the Offering Document, the Subscription Application form and the Investment Management Agreement as well as other Service Provider agreements.
It will also be necessary to prepare a Pricing Policy Document with the Fund’s Independent Administrator and, depending on the strategy, an Asset Verification Agreement, also with the Administrator. There are various Hedge fund strategies one can follow as mentioned below.
Hedge fund strategies are generally classified among four major categories: global macro, directional, event-driven, and relative value (arbitrage). Strategies within these categories each entail characteristic risk and return profiles. A fund may employ a single strategy or multiple strategies for flexibility, for risk management, or for diversification. The hedge fund’s prospectus, also known as an offering memorandum, offers potential investors information about key aspects of the fund, including the fund’s investment strategy, investment type, and leverage limit.
Your investors will want to know exactly how you plan on making them money. Just saying you’re a global macro fund or a value investor won’t cut it – you need to show that you have a different way of executing those strategies with a repeatable process.
● Marketing and Sales Plan
Like any business, nothing happens until a sale is made. It is important to develop a sales plan for raising assets before you open your doors for business. One of the first steps in doing so will be deciding where you will try to raise assets. There are many potential sources of investors such as family and friends, High net-worth individuals, financial advisors, seed-capital providers, corporations, Wealth management offices & RIAs and many more.
Small hedge fund startups typically try to develop long-term relationships with seed capital providers, family and friends and high net worth individuals (directly or through their financial advisors). Working with institutional-quality investors who might eventually invest $25 million to $100 million at a time can be difficult until you have a two-to-three year track record and well over $100 million in total assets under management.
For marketing and sales purpose, simple activities such as newsletters, letterheads, website, professional logo, a powerful powerpoint presentation, business cards, brochures etc should be followed before launching your hedge fund.
All marketing and sales materials should be produced under the direction of your chief compliance officer or compliance consultant, as there are many limitations and details that need to be approved and reviewed.
● To Sum it up
Starting a hedge fund is a challenging endeavor that takes a multi-year commitment to refining your strategy, building a team, and finding both trading and marketing niches where your firm can profitably operate. While many hedge funds fail before they become large enough to be viable businesses, following the tips above will help save you time and gain some early momentum in marketing your portfolio.