How To Start Your Own Hedge Fund



[image url="http://static.businessinsider.com/image/4ab8f9d0ab877e5d548b133d/image.jpg" link="http://www.businessinsider.com.au/how-to-launch-a-hedge-fund-2009-10/decide-how-much-you-need-1" caption="" source="" alt="" align="left" size="xlarge" nocrop="true" clear="true"]
After taking a beating, and watching investors flee in droves, hedge fund assets are back to nearly $2 trillion, according to HedgeFund.net.And with capital flowing, thanks to the Fed, it’s time for you, yes you, to grab your share of the pie.

Got the guts? Here’s how to do it! >
“Contrary to conventional wisdom, it’s actually a favourable time to start a hedge fund,” says Turn Key Hedge Funds. Reasons include that “the market is inevitably recovering after a historic collapse and all things being equal, riding that recovery is possible;” and “there remains an appetite among high net worth individuals and institutions to capitalise on investment opportunities outside the rank and file.”

But, you can’t just start a hedge fund in your sleep. You need to know a few things about the new environment.

“Obviously, this financial crisis has shifted how the hedge fund industry operates,” says Evan Rapoport, a Managing Partner at consultancy HedgeCo Networks. “The biggest change in the industry investors have become extremely cautious, especially in dealing with new funds and the increased awareness of hedge fund infrastructure.  This current market place is the most difficult for raising capital for hedge funds.”

Richard C. Wilson, a consultant who runs the Hedge Fund Group adds that “the environment for starting a hedge fund right now is tough…investors are weary of non-institutional hedge funds and there is a lot of competition for seed capital and investor attention among emerging hedge fund managers.”

So you’ll need plenty of patience besides great investment ideas and tough-to-get seed money. In the past, some funds could be profitable in three years; now, Wilson says there’s a five to seven year range for most funds more in line with typical business break-even periods. “Running a hedge fund is becoming a very long-term game.”

Here’s our step-by-step guide >>

[slideshow]
[slide
permalink=”decide-how-much-you-need-1″
title=”Decide How Much You Need”
content=”Before the financial crisis, some hedge funds were started with as little as $1 million. That’s almost impossible now.

‘Many funds have successfully launched with much less, but typically, we say the $5 million mark is the critical mass for a hedge fund to launch,’ says Rapoport of HedgeCo Networks. ‘From there, the success rates are much higher. $20 million is another momentum point where large groups of outside investors will begin to pay closer attention to a fund. At $100 million, the fund becomes a viable option for institutional investors.’

While more difficult, it’s still possible to start small. Turn Key says a fund usually needs at least $1 million — ‘Funds in the upper $100ks are not unheard of, but the overhead associated with running a hedge fund essentially proscribes anything below that.'”
image=”http://static.businessinsider.com/image/4ab8fad28eeb4e7a0848b668/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”raise-the-cash-2″
title=”Raise The Cash”
content=”Obviously this is the tough part. Finding even $5 million today is a challenge.

‘Earlier this decade, we used to see many active seeders, which sought funds trying to launch, but in the economic climate we face today, seeding is no longer easy to find,’ says Rapoport, making for a Catch-22. ‘Investors don’t want to invest in a hedge fund that doesn’t have capital or a track record.’

What to do? Start with family, friends and acquaintances for initial investors. Or show commitment by using your own money.

Phil Goldstein, co-founder of hedge fund Bulldog Investors suggests old fashioned networking is best: go on a golf course and convince rich people you have talent. “You can be the smartest investor in the world if you don’t have access to capital, you won’t go anywhere.””
image=”http://static.businessinsider.com/image/4ac65911e1fa7546697db00c/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”pick-a-strategy-3″
title=”Pick A Strategy”
content=”Once you have the money, the next step is distinguishing yourself from the thousands of existing funds. So, what works?

Turn Key says there’s a trend toward equity options strategies and interest in the commodity futures area. Rapoport says top strategies are: event driven, emerging markets, distressed debt, and arbitrage. And not everyone seeks absolute returns; other fund managers look for higher than average risk-adjusted returns. In fact, the first hedge funds were created for capital preservation rather than wealth generation, hence the ‘hedge’ name.

But all agree there’s more to success than the right investments. Many indices are up more than 25 year year to date, but a lot of funds that are top performers one year can be sluggish performers the next, says Rapoport. And Turn Key adds that the ‘relative success of these strategies, however, depend not only on market conditions, but the skill and discipline of the fund manager.'”
image=”http://static.businessinsider.com/image/4ab8fb9ddbab501b2f829f82/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”get-a-broker-4″
title=”Get A Broker”
content=”There’s little more important to a hedge fund than the right prime broker.

Funds either get personal recommendations or hire a consultant who can make introductions, among other services. Regardless, it’s a tricky courtship process to find someone you like and who likes you back.

Blue-chip names like JPMorgan or Goldman Sachs can make for instant credibility, but they have plenty of suitors to choose from so smaller funds need not apply. And a big name doesn’t mean great performance, e.g. Bear Stearns.

Turn Key recommends boutique brokers that can give affordable, personalised service, like Torc Investments and Research based in New York, who primarily clears through Penson Financial Services.

Regardless, there are important questions to ask. Small funds shouldn’t ask “what sort of commission rebates am I going to get?” or “can you introduce capital to me?” but “will you be there for me if something goes wrong at the clearing broker?” “is the platform what I’m looking for?” and so on. Customer service is what the manager buys at the primer broker/boutique fund launch level.’

Also trading methodology matters, says Rapaport: ‘Is it a black box system or some sort of program trading where high-speed execution is much more important? Is it fundamental stock picking where extra information from the floor broker is helpful? What does the fund invest in? Equities, options, futures, currency? Does the fund invest globally or domestically?'”
image=”http://static.businessinsider.com/image/4a68c6dea9416d2d5a03df43/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”pick-a-location-5″
title=”Pick A Location”
content=”Most hedge fund dreamers see themselves making bold investment decisions in Greenwich, New York or London.

While expensive, such prime locations may still make sense. There are obvious advantage to being in business centres, and commercial rents have fallen. Greenwich, for example has ‘specific advantages,’ especially prestige in large amounts of local capital, says Rapoport.

New York, Chicago, London, and Swiss cities have lots of qualified investors, and areas with lots of hedge funds tend to have lots of fund of funds, which are some of the most active investors in the industry.

Others disagree. ‘We find location to be virtually irrelevant,’ say the Turn Key team. ‘Further, the applicable regulatory regime — and consequently where you set up shop — hangs on where the fund manager him or herself lives and works….Most new managers are not in a position to relocate to Greenwich or New York just to start their funds and, in truth, there’s no reason why they should have to.'”
image=”http://static.businessinsider.com/image/b3b9b91470ff4f4acef4b900/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”build-the-team-6″
title=”Build The Team”
content=”Like brokers, building the right team of lawyers, accountants and auditors is critical.

The team of experts quoted here are eager to make such introductions, claiming its a wild world by yourself. For example, recommended accounting firms include Rothstein Kass, Decosimo, BDO Seidman and Kaufman Rossin.

The hedge fund launch consultants are one stop shops for find advisers — if you can afford it. Otherwise, ask other hedge fund managers and check service provider lists on sites like hedgefund.net.”
image=”http://static.businessinsider.com/image/4aaf9acf0f2fda1d2bafc11c/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”get-image-help-7″
title=”Get Image Help”
content=”Many hedge funds revel in their secrecy, but the excess of some billionaire industry figures has come to symbolise pre-financial crisis excess.

Most have toned it down, but it’s smart to get public relations help in advance.

Plus, should massive investor redemption come like they did in 2008, you’ll need crafty “no, we really aren’t having liquidity issues” letters.

And if investments do poorly, just direct public relations to blame it on rumours — that’s what Citadel, Cerberus and others funds have done.”
image=”http://static.businessinsider.com/image/bb7a6c7914a79e4941527f00/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”pick-a-good-name-8″
title=”Pick A Good Name”
content=”A last step is to pick a name.

Pick something conservative that reflects the fund’s idea and strategy. For example, Goldstein of Bulldog Investors says “We thought it suited our style of investing — we’re activists so a bulldog is a friendly dog, it’s not mean like a pittbull, but it’s but tenacious, and that’s our main quality.” Makes sense. Other good, simple examples are Fortress Investments Group, Renaissance Technologies and Lone Pine Capital.

Sounds easy, right? You’d be surprised. A Lehman Brothers veteran just launched a hedge called Ground Zero Strategic Commodities Fund. Yikes.

And ex-Bear Stearns managers Ralph Cioffi and Matthew Tannin are being tried for alleged fraud at their ‘Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund.’ Way too complicated, and in hindsight, it screams sub-prime.”
image=”http://static.businessinsider.com/image/4ad3be82000000000041e992/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”court-institutional-investors-9″
title=”Court Institutional Investors”
content=”Attracting institutional investors takes a hedge fund into a different catagory.

It usually takes at least $100 million to be credible, according to Rapoport of HedgeCo, but the gains can be huge once pension funds, universities and others start trusting their cash with a fund.

To attract the big boys, transparency is critical: explain your strategy in simple terms and some of your investment positions. In a post-Madoff world, complicated proprietary strategies can be equated with snake oil if sold as too difficult for a lay-person to grasp.

And a note on style: While hedge funds can be less formal than banks, it’s important to keep conservative when pitching potential investors. “Institutional investors are not the creative bunch…they like things square,’ a source tells us.”
image=”http://static.businessinsider.com/image/62b9b9141287c649468a4300/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”be-ready-to-fail-10″
title=”Be Ready To Fail”
content=”

In stable financial markets, about 10 or 15 per cent of hedge funds fail. That said, the rate of failure is hard to determine because ceasing to operate doesn’t necessarily mean failure, and private companies don’t have to announce that they’re finished.

Regardless, it’s even harder for small funds to make it. According to Turn Key, only 10 per cent or so of boutique funds succeed; most fail because they can’t raise enough money.

‘Funds which manage to get past the initial barrier of capital-raising only to fail usually do so because the manager ultimately lacks discipline with respect to his or her trading or investment strategy,’ says Turn Key. ‘The number one post-mortem admission from fund managers who’ve failed is “We changed our strategy because of [market conditions/we thought it would work better/we started losing money/we got nervous/etc].” If you’ve come far enough to start a fund, if you’ve had success proprietarily for an extended period of time, across multiple market cycles, all with a single strategy, stick to it, no matter what.'”
image=”http://static.businessinsider.com/image/a97a6c7902d0bf49b06d8e00/image.jpg”
caption=””
credit=””
credit_href=””
]
[slide
permalink=”see-also-11″
title=”See Also”
content=”Now that you’ve got a hedge fund off the ground, here’s how to buy your own private jet.
image=”http://static.businessinsider.com/image/4aafaa2a2a50e2154d2ff529/image.jpg”
caption=””
credit=””
credit_href=””
]
[/slideshow]

NOW WATCH: Money & Markets videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.