Starting a hedge fund requires specialized expertise, substantial capital, countless regulatory and operational details, and successfully raising investor assets. It’s a major undertaking not for the faint of heart. This comprehensive guide will walk through the entire process on how to start your own hedge fund
While the barriers to creating a hedge fund have lowered over time, it still requires deep knowledge, planning, legal compliance, infrastructure, and business development skills. Bringing on partners can ease the burden. Do ample preparation before taking the leap to launch.
Develop a Clear Investment Strategy
The first step is defining your hedge fund’s investment strategy, process, and areas of focus. This drives all subsequent decisions. Key elements include:
- Objectives: What is the goal of the fund? High returns, low volatility, diversification? Define your value proposition.
- Strategies used: Long/short equity? Event-driven? Quant? Specify which strategies you will employ.
- Instruments traded: Stocks, bonds, derivatives, currencies? What will you trade and how?
- Markets and sectors: Which geographies? Industries? Factors? Will you specialize?
- Research and analysis: What is your edge? How do you pick investments? Be specific about your process.
- Portfolio construction: How many positions? Leverage used? Gross vs net exposure? Risk management rules?
- Time horizons: Short-term trading? Long-term investing? Define your holding periods.
You need a clear identity and sound strategy you can articulate to investors. Your personal expertise should inform this strategy focus.
Create a Business Plan
Every new business needs a business plan to evaluate the feasibility of the venture. A hedge fund business plan covers:
- Executive summary: High-level overview of the fund strategy, team, and key details.
- Fund strategy: Articulates your strategy, edge, and approach to generating returns in detail.
- Fund terms: Proposed fee structure, minimum investment, liquidity terms, capacity constraints.
- Team bios: Background on managers, experience, credentials, track records. Builds credibility.
- Market opportunity: Estimates total investable market size, growth, competition, industry trends.
- Operations plan: How the back office, middle office, accounting, trading, infrastructure will run.
- Service providers: Recommendations for prime brokers, custodians, auditors, legal, compliance, tech, marketing.
- Financial plan: AUM growth projections, fixed and variable cost forecasts, estimated breakeven point, and profitability analysis.
- Risk factors: Assessment of execution risks and mitigants for the plan.
The business plan helps test assumptions and determine if the opportunity warrants moving forward. It also communicates the fund details to your seed investors.
Choose the Right Fund Structure
Hedge funds are typically structured as private investment partnerships with the founders as general partners and outside investors as limited partners. The main entity choices are:
- Limited Partnership (LP): Most common due to tax benefits and limited liability. Profits flow through to partners. Downside is limited filing requirements. Delaware and Cayman Islands popular jurisdictions.
- Limited Liability Company (LLC): Gives tax benefits of partnership with more flexibility. Requires filing annual tax returns.
- Corporation: Rare for hedge funds due to double taxation of profits.
- Offshore fund structure: Many set up a parallel offshore fund in a tax haven to attract foreign/tax-exempt investors. But adds complexity.
The LP structure is best for most new hedge funds. Consult a hedge fund lawyer to determine the ideal structure for your situation. Where you register has implications for taxes and regulations.
Handle Legal and Compliance Requirements
Hedge funds must comply with various legal and regulatory requirements:
- Register as an investment advisor with the SEC under the Investment Advisors Act of 1940 and applicable state laws. Even with exemptions, anti-fraud provisions apply.
- Develop a compliance manual detailing policies for regulatory filings, capital management, trade monitoring, data protection, business continuity, and conflicts of interest.
- File Form D to qualify for a private placement exemption under SEC Regulation D rules. Allows you to raise capital without full SEC registration.
- Prepare a private placement memorandum to outline fund details, strategy, terms, risks for investors. Required for fundraising.
- Develop limited partnership agreements and subscription documents aligned with your PPM terms.
- Implement compliance software to monitor investment guidelines, risk exposure, and pre-trade compliance. Automates checks.
Engage a hedge fund lawyer to ensure you satisfy all SEC, state, and self-regulatory organization rules from the start. Ongoing compliance is also essential.
Assemble a Strong Team
A hedge fund is built on the expertise of its people. Bring together specialized talent:
- Portfolio managers: Need experienced PMs with a verifiable track record of success in your strategy. Renowned alumni can help market the fund.
- Research analysts: Sophisticated data analysis and investment research capabilities are vital for idea generation.
- Quantitative talent: For quant funds, recruit PhD quants with modeling, machine learning, and data science abilities.
- Trading: Traders with trading platform expertise and execution skills suitable for your strategy and markets are essential.
- Technology: Developers to implement trading systems, data management, analytics applications, website, investor portal, etc.
- Operations: Fund accountant, back office for documentation, settlements, accounting. Middle office for risk management and order management.
- Investor relations: Dedicated IR professional to address investor inquiries, report, market the fund.
- Compliance: In-house counsel or consultant to ensure legal and regulatory compliance.
- Administrative: Office management, accounting, marketing, human resources support.
Identify gaps and bring on the best team suited to your strategy. Staff up gradually as you scale AUM.
Build Robust Infrastructure
To operate effectively, hedge funds need to implement:
- Portfolio management system: Software like Bloomberg AIM, Advent MOXY, SS&C Geneva, others for position management, risk analysis, and order generation. Integrates with other systems.
- Order management system (OMS): Enters and tracks trades from PMs to execution. Popular systems include Eze Castle Integration, FlexTrade, Charles River.
- Data management: Tools to store, analyze, and transform data for analysis. May include proprietary data. Look at vendors like Preqin, eVestments, Eidos.
- Trading workstation: Fast trading terminals like Bloomberg Terminals for news, data, analytics, and trade execution.
- Reporting system: Automates generating investor statements, performance reports, and regulatory filings. eFront, SS&C Vision are top reporting systems.
- Secure email and communications: Implement encrypted email, virtual data rooms, videoconferencing, and collaboration tools.
- Business continuity/Disaster recovery: Resilient colocation facilities, backups, redundancy for systems and connectivity.
- Cybersecurity: Endpoint detection, access controls, encryption, network segmentation. Prepare an incident response plan.
Budget at least $150K annually for a robust technology stack and market data. The COO oversees selecting and implementing these systems.
Secure Service Providers
Hedge funds rely on specialized external service providers:
- Prime broker: A bulge bracket investment bank that handles trade execution, margin financing, securities lending, and custody services. Shop for best financing rates.
- Custodian bank: A custody bank to hold assets not financed by a prime broker. Can act as fund auditor and administrator too.
- Auditor: Verifies annual financial statements and performs a SOC 1 audit of controls. Needs hedge fund expertise.
- Lawyers: Corporate, partnership, compliance attorneys assist with fund formation, contracts, filings, and ongoing legal needs.
- Tax: Accounting firms or dedicated hedge fund tax specialists handle partnership tax returns and investor K-1s.
- Fund administrator: Handling valuations, accounting, capital calls, subscriptions, and transfers. Leading administrators include SS&C, Citco Fund Services, and Morgan Stanley Fund Services.
- Insurance brokers: Arrange D&O insurance, professional liability, cyber insurance, and other coverages.
Take time to evaluate multiple providers to get the best fit and pricing for your fund. Meet shortlisted firms before deciding.
Seed the Fund With Your Capital
Most institutional investors want to see managers investing significant “skin in the game” before they will invest. To establish a track record, expect to invest:
- Personal capital: At least $1-2 million of your own savings invested alongside external investors. This demonstrates conviction and alignment.
- Friends and family: Tap your networks for at least $5 million in seed capital from associates to reach $10 million target. Offer preferential terms for early investors.
- Angel investors and family offices: Pitch pre-launch to qualified ultra high net worth investors willing to take more risk.
Securing your first $10-25 million in seed capital takes 12-18 months of hustle. Budget a year of living expenses before meaningful management fee revenue starts.
Market the Fund to Investors
Marketing a new fund takes extensive outreach:
- Create marketing materials: an investment overview presentation, fact sheet, letters, brochures conveying your strategy, terms, team credentials.
- Fund databases: Create profiles on established platforms like BarclayHedge, HedgeFund.net, and HedgeCo.Net to get visibility with allocators.
- Network aggressively: Leverage alumni networks, conferences, family offices, LinkedIn, and professional contacts to find qualified leads.
- Get certified: Earn CAIA, CFA, and other alternative investment credentials to support credibility.
- Host educational events: Events build brand. Consider co-hosting with a fund platform or seed investor.
- Respond to RFPs and RFIs: Complete detailed diligence questionnaires from asset allocators.
- Offer co-investment opportunities: Let larger investors invest directly into select deals alongside the fund for a closer look.
- Publicity: Earn press mentions highlighting launch, strategy, pedigree to bolster marketing.
- Leverage service providers: Auditors, prime brokers, law firms have introductions to investors.
- Travel and meet: Schedule in-person meetings and on-site visits which are critical for commitments.
With perseverance, you can attract $100 million to $1 billion in assets to sustain the fund long-term.
Take in Investments and Start Investing
Once you secure commitments, the real work begins by:
- Finalizing legal documents: LP agreement, subscription agreement, compliance manual.
- Obtaining signed documents: Get investor signatures on LP agreement and completed subscription forms.
- Collecting capital: Call committed capital from LPs based on your investment timeline. Most transfer via wire.
- Accepting new investors: Review subscription forms for compliance. Confirm accredited status. Approve transfers.
- Deploying capital: Start making investments based on your strategy and guidelines once you have critical mass of assets.
- Establishing operations: Trading, portfolio management, risk monitoring, reporting, accounting/valuation, investor relations all kick into high gear.
- Ongoing fundraising: Continue marketing the fund to replenish assets as early investments are realized.
With sound operations and portfolio management, you can establish a track record to help secure additional assets.
Expand the Fund Over Time
Growing a sustainable hedge fund business takes time:
- Build a track record: Clearly demonstrate consistent risk-adjusted returns to investors quarter after quarter. Shoot for 3-5 years of audited returns.
- Market momentum: Asset growth tends to accelerate once a fund reaches $100 million in AUM and has a solid track record.
- Add strategies: After success with initial strategies, can launch new products using accumulated knowledge and infrastructure.
- Returning capital: Limiting the fund’s size to remain nimble may require returning capital to earlier investors as you grow.
- New business lines: Expand over time into complementary strategies like private equity, real estate, credit, royalties, venture capital. Or launch a startup incubator, data service, etc alongside fund management to create a platform.
- Build the brand: Increased media profiles, thought leadership and awards validate the fund as an enduring player.
With hard work and investment acumen, a boutique fund can grow into an independent asset management firm overseeing billions for investors globally.
Key takeaways for launching a hedge fund:
- Define your fund’s strategy, edge, processes, and team experience definitively from the start.
- Prepare a detailed business plan and model out the operational requirements and costs.
- Select optimal fund structure and jurisdiction. Handle legal filings and compliance requirements early.
- Build a team combining investment talent, trading, quant research, operations, technology, marketing and compliance capabilities.
- Implement specialized systems for portfolio management, risk analysis, order management and reporting.
- Forge relationships with reputable service providers like prime brokers, fund administrators and auditors.
- Seed the fund substantially with at least $10-25 million of founders, friends, family capital.
- Market extensively to secure anchor investments to start managing external capital.
Starting a hedge fund is a major endeavor requiring proper planning, a strong team, infrastructure, and substantial seed funding. But by assembling the right components and proving results, emerging managers can ultimately thrive. Those able to execute have potential for great upside.
Launching a hedge fund requires remarkable expertise across investing, marketing, operations, compliance, technology and human capital management. Bringing on strong partners and early hires in non-investment functions allows portfolio managers to focus on investment strategy and returns.
Meticulous planning and preparation are necessary to build an institutional-grade business. Seed financial backers willing to take more risk also provide invaluable credibility. With proper resourcing and commitment, talented emerging managers can achieve independence. But they must prove themselves to scale assets over time.
The path is certainly arduous, but building an enduring, profitable investment firm can be tremendously rewarding for those able to meticulously execute each step. For the right managers with determination, a customized, differentiated strategy, and patience through long fundraising cycles, it’s possible to start your own hedge fund and thrive.
Frequently Asked Questions
How long does it take to start a hedge fund?
Plan on 12-18 months to start a hedge fund:
- 3-6 months to form the entity, handle legal and regulatory filings, and build initial infrastructure.
- 6 months to develop thorough investment process, research pipeline, backtest models.
- 12-18 months of active marketing and meeting with investors needed to fundraise seed capital.
Many underestimate the challenges of securing investor commitments. But with dedication and perseverance, it is possible to launch within about 1.5 years. Having an established track record and reputation can accelerate marketing. Bringing on a partner with fundraising expertise also helps get to critical mass faster.
What documents are needed to start a hedge fund?
Key documents required to start a hedge fund correctly:
- Private placement memorandum
- Limited partnership agreement
- Subscription agreement
- Investor questionnaire
- Fund strategy statement
- Pitchbook/marketing materials
- Compliance policies and procedures manual
- ADV Form registration with SEC
- Form D filing
- Agreements with service providers
- Infrastructure vendor contracts
Take time to get legal, compliance and marketing materials in order. Work with experienced hedge fund counsel to customize documents for your specific needs. Thorough documentation protects all parties.
Can I start a hedge fund by myself?
It is possible but quite difficult to start a hedge fund alone. The workload of launching and running a hedge fund is immense for one person.
Consider bringing on partners and hiring staff for:
- Portfolio management
- Marketing and investor relations
- Trading and technology
- Operations, accounting, compliance
Other benefits of having co-founders or hiring a team:
- Share workload – no bottlenecks if dependent on just yourself
- Experience and skillsets fill gaps in your expertise
- Adds credibility when engaging investors and counterparties
- Additional personal capital to seed the fund
- Shared risk if fund struggles or hits hurdles
At minimum, onboard a COO/CFO, compliance lead, and investor relations early. But identify any skill gaps on the investment side too. Starting with 2-3 founders is ideal.
How much money do I need to start a hedge fund?
You typically need at least $2-10 million to start a hedge fund:
- $1-2 million minimum of your own capital
- $2-5 million from friends, family, early backers
- $100K budget for legal, travel, and marketing expenses
- $150K+ for initial technology infrastructure
- $250K+ to support operations for the first 12 months
This seed capital covers initial costs until management fee revenue starts. The more seed funding, the easier it is to get started. $10-25 million seed capital targets give you 1-2 years of operating cushion.
Some successful individual PMs launch after leaving firms by leveraging their reputation. However securing anchor investments from institutions, family offices, or platforms can be crucial for first-time fund managers.
In another related article, Top 5 Hedge Funds of 2023 Based on Performance and Assets Under Management