The vast world of hedge fund investment is both lucrative and risky. Being both an example of American economy innovation and the subject of media vilification, there’s no mystery that creating and running a hedge fund is no easy task.
While we are setting out to tell you how to start a hedge fund, the first step is initially understanding what a hedge fund is.
At its core, a hedge fund is a partnership between investors and a fund manager. Some hedge funds are made up of thousands of investors with valuation in the billions, while other smaller hedge funds are built from a few large players who pool their money. In some cases, hedge funds take on massive risk by using borrowed money.
A hedge fund then uses all the money from investing entities and develops a portfolio of investments. Most often this is a highly-diversified and well-monitored batch of financial properties to mitigate risk and offer some promise of future returns. The amount of risk involved is essentially up to the fund manager, though many hedge funds have boards built from major investors.
With this simplistic definition in mind, let’s now explore the main components of building a hedge fund from scratch.
There are several important types of people involved in hedge funds. This is not only the investors and fund managers, but also traders and legal staff, plus additional office staff for administrative tasks and other generally corporate needs.
Investors – These people are the stuff your hedge fund is made out of. Whether the fund is built from the fortunes of a few mega-billionaires or through small contributions from thousands of people, the concept is the same—hedge funds are essentially pools of money put together by a collection of investors.
You will want to answer for yourself the question of how many people you want involved in the hedge fund. In general, the more people involved, the less risk incurred by each individual investor. When you come to fundraising, this will be a major question from smart investors, as no funding member wants to bear the burden of too much rish.
Managers – Fund managers are the people who are overseeing the processes that make the fund run. They are also the people who generally set the course of the fund in terms of what investments are made.
When thinking about managers for your potential future hedge fund, you want to strike a balance of someone with an analytical and managerial mind, as well as someone who is not uncomfortable talking to investors. A keen understanding of how investments work is crucial for a successful hedge fund manager.
Legal Team – There is a near-insurmountable heap of red tape to jump through when starting a hedge fund. Especially given the financial crisis of 2008, governmental bodies such as the Securities and Exchange Commission have set up stringent regulations that no layman can take on.
Having proper legal representation from the start will ensure that all manners of registering the hedge fund, obtaining proper licenses, and processing the myriad applications involved are done correctly. This will set your fund up for success—skimp on your legal team, and you could find yourself in troubled waters down the road.
Traders – These are the foot soldiers of your hedge fund. These are the guys who have their pulse on the markets by the second, and who are the biggest contributors to the growth of the fund.
While it’s obviously advised that you find someone who has experience and a track record of success, your initial funding might limit you to beginners in the industry. There’s no right answer here, as it is a balance of how much money you’ve raised and what you’re willing to spend on staff.
Anyone who buys into a hedge fund will want to know how you plan to make them money. Some hedge funds run the gamut of industries, choosing based simply on performance over time. Others will specialize in specific industries, or specific sizes of companies.
You’ll want to think long and hard on where exactly your investments will lay, and for how long. A deep study into the histories of companies, and the valuations of other hedge funds, will help point you in the right direction toward your own fund’s investment strategy.
You’ll also want to think about how you’ll sell the strategy of the fund to potential investors. In the end, your investment strategy and portfolio are the product being sold, with the promise of future gains being the crop to be reaped.
Develop a strategy that is at once bold and takes a page out of other funds’ books. While it’s great to have that completely new and novel idea, you’ll run into a difficulty raising money and getting things off the ground. Develop a strategy that is not bold enough, and potential investors won’t believe the returns to be worth the risk of putting money into a new hedge fund.
Technology. Space. Location. All this will have a major impact on the success of your hedge fund, in some ways overt, while others more subtle.
Technology – The software you use is a major part of the workings of your hedge fund. Technology related to tracking stock prices, accounting, and communicating with investors are all part of the front end of your hedge fund, while the back end is supported by order management systems (OMS). These programs help execute purchases or sales of securities.
Space – Here is where you can let your creativity thrive. The space your hedge fund operates within is important for a number of reasons. Everyone’s under high stress as you’re trying to get a big undertaking off the ground. You need space not only to meet with investors, but a place for your traders to work together, rooms for meetings, and attractive furnishings for potential investors.
Finding a space for all your hedge fund’s needs is one part of the process. Furnishing your space is a whole other ballgame .
You’ll need to know who is going to be using the space, and for what duration of time. Comfortable and ergonomic chairs that can be used for hours on end are crucial as your team puts in many hours getting things off the ground.
Furnishing spaces attractively is one way you can instill confidence in potential investors. Setting up meeting rooms with proper boardroom tables and comfortable chairs will be important for selling to those investors, or meeting with big-time players on your team for long meetings.
You’ll also want to think about workstations for your integrated technology team members. Some parts of your IT staff will most assuredly need access to several monitors, meaning a well-designed and multifunctional setup is key to their success.
Location – Will you be located in the financial epicenter of New York City? Do you want to keep costs down and head to Duluth? Location is important, especially when knowing who you want your potential investors to be.
Having access to an airport is important considering the generally national reach of the hedge fund management business. You’ll also want to allow big-ticket clients to have access in case they want to visit the office.
You’ll also have access to different qualities of talent pools based on location. For instance, there’s far more financially-savvy traders in such economic meccas as San Francisco and New York than in cities known for other industries like Kansas City or Portland, Oregon.
There’s a Lot to Think About
Starting a hedge fund is a herculean task. That means this guide is by no means an exhaustive to-do, but a high-level overview of some aspects of starting a hedge fund.
Getting all the legal aspects in order is crucial, and finding investors is the most important part. How you accomplish both tasks will take time, money, and a lot of head scratching. But, with the right mix of novel or cutting edge ideas and a close attention to what works and doesn’t, you can be well on your way to building others’ wealth—as well as ensuring yours grows with it.