Starting A Hedge Fund - A Checklist

So one of the most frequent questions we are frequently asked is that “What do I need to start my own hedge fund?”. If you are planning to form a hedge fund on your own, then refer to our recommended checklist for the best preparation.

1. Leadership and entrepreneurship

Starting a hedge fund isn’t easy as it sounds. Being the founder of a hedge fund, it means that your work is not only as a portfolio manager, but you are also a business owner. Being a successful trader or investor does not necessarily mean you can manage a hedge fund. What you also need are strategic thinking skills, people management skills, persuasion/influencing skills and quite more to effectively organize various departments and parties you work while running your fund.

2. Strategy

In order to successfully form a hedge fund, strategy is among the most important factors, since it does not only support you to come up with wise and consistent decisions in the long run, but it also helps impress your investors by letting them know exactly how you are going to generate money, escpecially when you are new. There are several strategies that you can refer to, such as global macro strategy, market neutral strategy, etc. To know more about different strategies you can adopt, click here.

But one important note that when you are presenting your strategies to your investors, don’t just simply call the name of the strategy such as global macro, but to explain that you are able to execute these strategies with actions in a repeatable process.

3. Track Record

Once you have a strategy, your next work in the hedge fund forming process is to prove that your strategy has been effective under different market conditions. Actually, this is harder than it looks, since there may be prohibitions from taking past performance record as marketing materials for your new fund. One more thing to remember is that if you are able to use your numbers, then make sure that such figures can reflect your investment decisions, as well as how the used strategy similar to the new one of your new fund.

In general, institutional investors such as endowments, pensions, etc. will look for a 3 year-long track record. Meanwhile, a 12 to 18-month track record is enough to please funds-of-funds, family offices, and high-net worth individuals.


However, there are two main things you need to notice here:

Firstly, if you were a research associate at a long-only dividend fund, your performance there will not prove that you can be the portfolio manager of a long/short international strategy fund.

In the circumstances that your figures are unable to use, or you are not from the buy-side, then you may prove your strategy work by investing in your personal account and having the performance audited by a top firm – expect to pay around $10,000 for a Big 4 firm to do it. Remember this rule: “If you can’t afford to audit your performance, you aren’t that good”.

4. Money

Since you just started your fund, you will need some initial investors to get going. Some example could be:

  •         Your own money
  •         Family and friends
  •         Family Offices
  •         University endowments, pension funds, and foundations
  •         Hedge fund seeders
  •         Funds-of-funds

There is no minimum amount that you have to raise to start a hedge fund, however, it should be able to cover the fund’s ongoing costs, your fee structure, and work backward to a level of assets under management (AUM) that can support that.

In addition, you should also bear in mind that as a starting point, most prime brokers won’t work with funds under $5 million in AUM. So the optimal solution would be to rock at your traditional firm and then get money from them to start your new fund. Hedge fund seeder firms work the same way: they give you the capital and in exchange, you will give back to them a portion of your fee income. Moreover, even when the fund launches, never neglect the importance of fundraising since you still have to need it for marketing as well as networking to develop your fund. Even the biggest fund managers with dedicated marketing departments can’t escape it – they are still brought it at the end of the pitch to close the deal.

5. Office Space

It is quite expensive to rent an office, especially in financial centers such as New York and London. Therefore, if you just started to build your own fund, you can consider cheaper options such as:

  • Your own house: Why not, right? Remember Michael Burry from The Big Short? He started his fund from home!
  • A hedge fund hotel: This option is usually set up by prime brokers, as managers get office space at below-market rates in exchange for steering brokerage business to the hotel’s host firm.
  • Sharing space with other managers: But make sure that you get along with the others and there is no direct competition here.

After a certain time of operation, if your AUM reaches $100 million and you have about $2 million/year in management fee to cover your office, you can consider upgrading your office.

6. Service Providers

External partners play an essential role in the firm success. Since institutional investors will seriously take into account your service providers’ reputation as a factor reflecting your credibility. Therefore, PAY FOR QUALITY, otherwise, if your providers aren’t appropriate, then you are getting yourself into trouble to develop your fund, as well as getting better-known investors on-board. So who are the key people you will need?

6.1. Lawyer

Once you decide to start your own fund, then your first call should be a good attorney. This will be one who provides you guidelines through the whole process, as well as referrals to other service providers.

6.2. Auditors

On a regular basis, external auditors will verify your performance. And as mentioned above, institutional investors will demand to see that performance before investing money.

6.3. Administrator

The majority of your back-office operations, such as trade reconciliation or allocation, will be handled by an administrator. However, don’t neglect the importance of this position since it is just “the back office thing” since institutional investors will be looking for a quality and reputable administrator.

6.4. Marketers

These people will work as a third party who finds your potential investors and pitch on your behalf. They can work for you in two different ways: Either on retainer for a specified time period or get paid a cut of the funds they raise for you.

6.5. Prime Broker

Prime Brokers provide leverage, let you borrow securities to short, and custody your assets. They also manage the brokers and dealers you trade through. When it comes to smaller funds (usually under a billion dollars), they may prefer to use an introducing broker, who’s p

6.6. IT and Technology

Certainly, at this point of time, you will need other technologies to support all the trades you make. But the good news is that the cost for IT tends to be much lower for fundamentally-oriented funds with little active trading. But, if you’re a quant fund or you’re doing any kind of automated trading, though, you’ll need serious computing power and serious cash to pay for it.

The consulting services of investment banking include two main areas:

  • Underwriting – Investments bankers raise capital, usually via the IPO process (selling stocks or bonds to an investor) on behalf of corporations.
  • Mergers & Acquisitions (M&A) – Advisory roles for both buyers and sellers of businesses, managing the M&A process start to finish.

7. Technical Setup

There are some legal terms and setup that you need to consider when starting your fund:

  • Fee structure: In the past, the standard fee structure was “2 and 20”, which means a quarterly management fee of 2% and annual performance fee of 20% on the gains. But the current trend is for lower management fee and higher performance fees. Some funds now adopt “3 and 50”, which is the highest fee in the industry.
  • Lockup Term: It is the length of time that investors’ money has to remain in the fund before it can be withdrawn. This term should match your strategy. To be more specific, if you adopt the global macro strategy, then you may have the liquidity to support a short lockup term, while an activist fund will need a longer one.
  • Redemption Term: In case investors want to take their money out, then how much notice do they need to give? Usually, redemptions are only allowed at the beginning of the accounting period (quarterly or annually).
  • Performance Targets: Is there a particular index that you need to outperform? Before collecting performance fee, do you need to beat any rate of return?

Generally, the structure of your hedge fund will rely on whether your investors are taxable or tax-exempt, their nationalities and the investment terms. $10,000 and $50,000 is the average amount you need to pay to setup a simple hedge fund. The more complicated, the more expense it requires (it can go up to hundred of thousands of dollars).

Once your fund meets certain criteria, you may have to register as an investment advisor with your state or the SEC. But different places will have different requirements, so make sure that you have done your homework there.


5. Conclusion

Above are the basic criteria you will need in order to successfully start a hedge fund. In order to thoroughly understand how such factors contribute to the hedge fund forming steps, review the entire process here.


Get our FREE Wall Street Career Roadmap & Career Planning Tool now!

Examine your chance of landing Wall Street jobs for your own background with our Investment Banking/ Wall Street Career Planning Tool. Explore the best-practice next steps to land your dream Finance job with our Career Roadmap – Downloaded and positively reviewed by +24,700 of undergraduate students and young professionals.