Hedge funds are like mutual funds, where investors pool their money to form a fund[i]. The fund then invests in securities and other related products at reduced risk with the intention of making a profit. It is called a hedge fund because it hedges or evades risk by making use alternative investment strategies.
A hedge fund has investors who are mostly high net worth individuals. Bank, insurance companies and pension funds may also put in their money in well-managed hedge funds. Many hedge funds have become highly successful making the persons who started them millionaires, a classic example being George Soros. So, what is it that you need to do to become the next Soros? How can you start your own hedge fund? Read on to know more.
Why start a hedge fund?
The answer is simple; you start a hedge fund hoping to make millions or even billions. Before you start making your plans, you need to keep in mind that up to 10% of hedge funds close down[ii]. To start a hedge fund, you need money. However, it does not mean you give up the idea, because it sounds scary. In reality, it is just like starting a new business. It needs capital, work force, technical expertise, marketing and an ability to take on a little risk.
You need capital to start a hedge fund. This capital can come from your own money. You may start the fund on your own or with partners, in which case you need to look for partners who can invest money. You can also look for other investors like Pensions funds, Foundations, and hedge fund seeders – people who invest in hedge funds. Remember that others will not put money in your hedge money unless they see that you have invested substantial money.
A hedge fund is just like a business. However, to run a business, you need the technical knowledge. You must have experience in the financial markets and in hedge funds before you can start your own fund. So, make sure you have a thorough understanding of the market, investment avenues, and the governing laws and regulations. If required, you can have advisors who are experts in this field.
Go through the formalities[iii]
The first thing is of course to name your fund. Choose a name that showcases what the fund offers to investors. You need to incorporate the fund in your state as a Trust or a Limited Liability company. You may have to pass a test to become an investment advisor if so, make sure you complete the requirements.
You need to register with the Securities Exchange Commission (SEC). This not only meets the legal needs but also gives your fund credibility. You may also need to register with the taxman. Once you are ready to start, you have to form a partnership with your investors and register it with the SEC. You may do well to take the help of a good lawyer to do all this.
A prime broker gives you leverage and helps you to manage the brokers with whom you deal. Selecting a good prime brokerage firm is a very important activity to be done before you start your hedge fund.
You need office space, employees to handle routine work, marketing support, and IT providers to help you access the terminals to start trading. Make sure you have a list of all that you need before you start. That would help you start and then manage your hedge fund in a seamless way.