If you’re reading this article, you must be one of the utmost enthusiasts in investing. You’re having a spectacular investment idea, you’ve been thriving your personal trading account, beating the market a few times and gaining high returns. You can’t wait to start a hedge fund on your own. I got it.
The ultimate goal of most buy-side aspirants is to become the Portfolio manager of their own fund. If you’ve broken into the buy-side, and thriving your track records through the years, great – let’s plan your hedge fund right away!
However, if you’re thinking of starting a hedge fund without sufficient experience in any buy-side institution, you might think twice:
- The fundamental of a hedge fund lies in the process of getting seed capital, which would be so much easier if you’ve had hands-on experience pitching stock or managing investors in previous hedge funds or asset management firms.
- Besides experience, it is the credibility and reputation you and your team built up during the time in the buy-side that likely to attract potential investors of your future fund.
In other words, Getting yourself into a Hedge Fund or an Asset Management firm is also the most practical path to your own hedge fund, for the sake of building connections with investors.
How to ensure that you’ll start a lucrative fund? Listed below is the most practical step-by-step tutorial to your dream – first beginning with getting recruited into a hedge fund:
0. Get Recruited Into A Hedge Fund
Let’s embark on the journey of networking, resume dropping, and interviewing to make way to a hedge fund of your preference:
0.1. Requirements – To be exact, what do they really want from you?
Hedge Funds require at least two things from you as an entry-level research associate:
You’ve already had a solid foundation in company research, financial valuation, and stock pitching. HF analysts are expected to deal well with modeling and presenting investment ideas in a clear, succinct way. Your previous experience should involve most of these skills.
It’s not only the paycheck that drives you to HF. You have to be seriously passionate about Investment, and planning on a long-term commitment at the fund. Large-scale recruitment and exit happen in top banks and firms, not here at such lean organizations.
(Not to mention these no-brainers: Graduated from a top school; excellent analytical skill, financial modelling experience; Interpersonal skills; Internships at top banks / firms… In short, you’re top of the top in the market.)
0.2. Okay, so what’s the plan?
Principles to get into Hedge Funds mentioned above: Prove your honed research skills and your great passion for investment. Sounds simple, but it’s way easier said than done.
The paths to HF vary, depending on your background and your current position at the time. A big picture of chances to get into HF can be seen in this Wall Street Career Planning, here we’ll show you the details:
You’re currently a student:
Great! This is a good sign that you could start preparing early and get ahead of your peers. During university years, you MUST develop an in-depth understanding of Investment and involve yourself in as much Investing activities as possible. Some suggestions are:
You’re a professional:
1. Popular track: Congrats, you’re in the target group of Hedge Fund headhunters IF…
– …you’re at entry levels in Investment Banking, Equity Research (or Sell-side research in general),
– or you’re a consultant.
Performing well at your current bulge bracket banks / top asset management, consulting firms, getting yourself into the top performers list, and you’ll be reached out by mega funds soon. Though for those whose firms are not among the top, extra effort should be put on aggressive networking with tier-1 headhunters so that you appear on the Hedge Funds’ radar.
2. Industry-specific track: Non-business, non-financial background… This is a less popular track for sector-focused funds seeking industry experts with background in science, technology, healthcare, etc.
Industry experts with backgrounds in science, technology, healthcare, etc. are definitely having an edge in recruiting at sector-focused funds. Within this niche, highly technical type of fund, they are best at being sector analysts, who understand the market and products most. One thing you have to prove more of is your passion for investment, which I’ve recommended some tactics above.
3. Do you need an MBA or a CFA?
Maybe. MBA degree at top 20 b-schools and the prestigious CFA designation helps build up your profile. They’re even more valuable if your background is irrelevant to Business or Finance. However, Hedge Funds in general are not favoring of entry-level candidates pursuing either of the qualifications. The reason: HFs look for Investment enthusiasts, the most high-achieving youngsters who’d better spend one or two years researching the market and investing, rather than doing academic work.
The more detailed, comprehensive guide to Hedge fund, and the Buy-side in general can be found here.
Getting into a hedge fund, working industriously to gain credibility, being an expert in particular strategies or investment instrument, and you’re good to move to the next step:
1. Starting your own Hedge Fund
Basically, starting a hedge fund is more difficult than forming a corporation or limited liability company (LLC) for a private business, since it involves navigating investment compliance laws, and you could get in trouble if you don’t seek professional help along the way. Yet being the manager of your own hedge fund will provide you with the opportunities to invest other people’s money for them, to which you and your investors are profitable. It may be an advantage if you are an experienced financial advisor who takes this as an exit opportunity from the investment banking industry and follows your own path.
In order to start a hedge fund, you will 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 private partnership. The detailed steps will be explained more detailed below.
1.1. Planning a Hedge Fund
a. Getting to know about Hedge Fund – How does it differ from Mutual Fund? (skip this if you’re already an expert)
A hedge fund is an alternative investment vehicle available only to sophisticated investors, such as institutions and individuals with significant assets.
b. Select a hedge fund strategy (skip this if you’ve determined your own)
Hedge funds managers usually get their start by achieving a successful investing track record throughout years of industry experience. This is how they attract their first clients and build out their funds. But even with the requisite experience, an overall vision for your fund is inevitable, where you express an idea of how it will generate returns for investors. There are different hedge fund strategies to which you can refer:
- Long/Short Equity Strategy
- Market Neutral Strategy
- Merger Arbitrage Strategy
- Convertible Arbitrage
- Capital Structure Arbitrage
- Event Driven
- Global Macro
- Short Only
Find out more about different hedge fund strategies here.
1.2. Creating a Hedge Fund Entity
a. Hire a law firm
If you decide to form a hedge fund, it is essential to have a lawyer who consult your process. Therefore, establishing contact with a group of lawyers who are experienced in financial law, and even better to ones who have experience specifically working with and starting hedge funds, they will be extremely supportive in the initial incorporation process, as well as other aspects of establishing the funds.
b. Decide what kind of entity you want to create
The typical entities used to create a hedge fund are limited partnerships, limited liability companies, and trusts.
- A limited partnership consists of two parts, including a general partner and limited partners. A general partner is the one who will serve as the manager and is personally liable for all the business’s debts and obligations. Corporations can serve as general partners. Meanwhile, limited partners are not liable for the debts of the company.
- For the most part, hedge funds are typically formed as limited partnerships, in which an incorporated group of investors acts as the limited partners, and an investment advisor acts as the general partner
c. Assemble an investment team of trusted advisors.
If you are spinning off from the Investment Banking industry, it is ideal to convince some colleagues to try with your venture. A good team is vital to success.
When establishing a team, your goal should be to first find people who you have a strong personal chemistry with, and who share your vision.
Next criteria should be experience. For example, if you are starting a market neutral fund, choose analysts who have experience doing the kind of high-level analytical work that is associated with creating a fund like that.
It’s hard to sell yourself to investors without first establishing a successful track record. Choosing workers with great employment histories and successful track records buying and selling securities will help in the long run, seeding your company with human capital and enabling you to hit the ground running.
d. Name your fund
Your fund needs to have a name attached to it before you can fill out the proper paperwork. It should be something that sounds memorable, stable and reputable. Use the name to promote your image.
Try to connect the name of your fund to its overall strategy in some way. For example, if you are operating a market neutral fund that attempts to eliminate exposure to the overall market and generate steady, reasonable returns, your name should reflect this vision.
e. Apply for a tax ID number:
In the U.S. your fund entity will need to get a Federal Employer Identification Number (FEIN) from the Internal Revenue Service (IRS). This can be done by calling the IRS or going to its website and filling out the necessary forms. The process can be completed online in a few minutes and totally free.
f. Register as an investment advisor:
You will need to register with the Securities Exchange Commission (SEC) as an investment advisor if you have 15 or more investors associated with your fund. If you have less than 15, you generally do not have to register with the SEC, but it is advisable to do so anyways since it adds to your overall credibility.
In addition, most states require an prospective investment adviser to pass the Uniform Investment Adviser Law Examination (Series 65). Some states will waive exams for holders in good standing of professional designations such as the CFP, CFA, or CIC.
To register you’ll also need to take the Series 65 regulatory exam. This three-hour test covers your basic knowledge of securities laws and practices as well as your understanding of ethics. When you pass the exam you will be a licensed investment advisor in your state.
Fill out a form U-10 with your state to register for the examination, then pay the small exam fee and schedule your test. It typically costs around $30.
1.3. Incorporating Your Hedge Fund
1.4. Raising your fund and growing
a. Write offering documents.
In order to attract investors to your hedge fund, you will need to create a set of documents that explain your fund’s goals and terms of investment. This generally takes the form of a prospectus or private placement memorandum (also called an offering memorandum). This document both protects the hedge fund, by assigning liability for losses to the investors, and the investors, by providing specific strategies that will be employed by the hedge fund.
These documents are required by securities regulators and must disclose specific information. Consult with professional legal counsel to ensure that you meet all of the necessary disclosure requirements.
b. Create an online presence.
Despite regulations that prevent hedge funds from publicly advertising their funds, they are allowed to set up informational websites. These websites can display the experience and backgrounds of the fund’s partners and provide information on the partners’ investment strategies. Having a clean, professional, and informative website can help foster trust in potential investors.
c. Seek anchor capital to seed your fund.
One of the most difficult parts of starting a hedge fund is to get the cash to get your fund off the ground. You need assets under management, which you’ll have to get from investors unless you’re independently wealthy and want to seed the fund yourself. The best way to make your case to investors is to have an air-tight operation as well as an established track record of success during previous employment.
It is essential for you to approach banks, venture capital firms, and wealthy investors with whom you or your team have prior relations with. It may be useful to establish strategic partnerships with these institutions where possible. Friends and acquaintances are also potential sources to raise money.
d. Promote your hedge fund.
This is when you express your strategy to investors, how it works, and why it would be a success through your salesmanship to convince potential sources of capital. You can also concentrate on your team track record to gain credibility. Consider offering reductions in your management fee or partial fund ownership to early investors.Be aware of the regulations affecting the marketing, solicitation, and sale of private interests on a Federal and state level.
After an initial period of success, if you earn large returns on your investments, you will find it much easier to attract investors.
e. Find a “prime-broker”
A prime broker is a bank that essentially provides you with all the financial services you need to run your fund. This includes lending you money, executing trades on your behalf, and providing you with what you need to do things like short sell stocks. They can also help you find investors for your fund.
You can approach institutions like Goldman Sachs, Morgan Stanley, Bank of America, or any other investment bank for these types of services.
f. Hire brokers
If your hedge fund is performing well and you feel comfortable enough to expand operations, it’s a good idea to start attracting talented brokers to expand your operation and start performing more transactions. You should look for dedicated employees who want to make money in a fast-paced and competitive environment. Get the word out that you’re looking for the best.
Note: Yet, growing doesn’t necessarily mean taking on more employees. Some hedge funds are successfully in business as one-man operations.
g. Purchase more office space.
As soon as you can afford it, move into a space appropriate for your business. Start small, but build a corporate office that will display the professionalism and spirit of your operation.
This is the detailed process of what you need to do to start a new hedge fund. If you have any questions regarding the process, comment below or check out the “Top common concerns when starting a hedge fund” article for better understanding.