After five years of successful investing, and several great picks that brought you solid gains, you are thinking about starting your own hedge fund or a similar investment vehicle. So many questions stand in front of you. The most obvious one is how much money do you need to start a hedge fund.
There are a lot of variables regarding costs when starting any firm, and a hedge fund is no different. There are legal fees, setting up the base of operations, hiring staff, luring new investors, and operational costs that will follow you. Depending on the plan and setup, the initial costs can be in a range between $200,000 and $1 million. Of course, it is always easy to spend even more. On top of that, you need to think about the annual cost, which will be easily anywhere between $150,000 and $500,000.
Before you start this costly and risky endeavor, you should collect all the precious data and information. Starting any business is a tricky undertaking, and if you want to deal with other people’s money, you should know all the knicks and knacks. We will go into depth, and try to bring as much light as possible to this complex topic.
Key Takeaways
- Hedge funds can be very expensive to start. When combining all the necessary elements that can draw sophisticated investors, the starting figure can be in a range between $200 thousand and $1 million.
- Besides starting costs, there are annual costs that every hedge fund needs to deliver so it can keep functioning. These figures go between $150 thousand and $500 thousand.
- Investing early into good personnel like managers and analysts, combined with a well-funded marketing campaign could bring solid returns down the road.
- When starting a hedge fund, do not forget about the fund's investment strategy. It is a crucial element of operations that will attract accredited investors to the fund.
What Is A Hedge Fund
In the crowded market of investment vehicles, hedge funds are a standout. They offer a unique mix of strategies and approaches that can deliver over-the-top returns if utilized properly. They also come with a blend of risk, due to hedge funds aiming to beat the market on every occasion.
Unlike mutual funds, which have more restrictive investment strategies, hedge funds can utilize a broader range of strategies to achieve higher returns.
Another feature of a hedge fund is investment strategies that can make you stand out from the crowd. You can combine a unique mix of approaches that can help you get the most out of the investments. Hedge funds can utilize short-term, and long-term horizons, bet on the debt, or invest in a wide array of assets.
Hedge fund managers can invest in liquid or illiquid assets, commodities, materials, publicly traded companies, private equity, real estate, currencies, and others. This allows hedge funds to construct a diversified portfolio resistant to market inefficiencies.
From the standpoint of running a hedge fund, this is not an easy starting point. You need top-of-the-class talent to achieve this. At the same time, you need to juggle risk management, find attractive investment options, and be able to draw in enough investors to properly function.
When you start adding the costs, it may seem that it will never end. That is why you need to shape up your plan and approach and have an answer to every question.
How To Acquire The Starting Capital To Start A Hedge Fund
If you are thinking about starting a hedge fund, to be able to draw high-net-worth investors you will need startup money. To get it you need to have a solid background, experience, and a wide professional network which would be a good recommendation to potential investors.
While in theory, it sounds great when someone with a lot of cash lying around offers you a helping hand, in reality, that almost never happens. You will need to dig deep and make a lot of personal sacrifices, and maybe, just maybe, you will be able to gather it.
You should start with your own contribution. For any savings, investments, or personal assets you have, you need to reroute them to hedge fund creation. You can raise capital from friends or family, and in return, you can offer them a share of the profit pie.
Besides your close circle, you will need a bulletproof plan for drawing in outside investors, including institutional investors. If you want to reel in high-net-worth individuals you need a plan of action that includes a realistic strategy, a risk management approach, and a team that can back it up.
Every experienced investor conducts due diligence before he parts with his capital. You want to be sure that he sees a reliable leader, with enough knowledge and experience that can deliver over the long term.
To attract institutional investors, you may need to establish an institutional quality hedge fund, which involves a more complex structure and higher initial capital.
To achieve all this you need a compelling pitch. In it, you will clearly state how you are going to manage money, and how you plan to multiply it. A good pitch must incorporate an understanding of your core audience and investment strategy.
Knowing what markets you are targeting, what sectors you know the best, and what are the current trends, will help you set a foundation for further negotiations. You should also put in the first plan any experience, educational background, and networking opportunities that you have.
Breakdown Of Costs Needed To Start A Hedge Fund
Legal, Administrative, And Investment Compliance Costs
Starting a hedge fund is not an easy task. The first step is to find a fund formation company that has plenty of experience in hedge fund structuring. Its task is to assess the current hedge fund structure and advise further steps.
Also, a formation company is responsible for creating the necessary documentation for fund formation. Those documents include a private placement memorandum or a limited partnership agreement. These administrative costs can rise to a figure in the range of $10 thousand to $50 thousand.
Just to set up a hedge fund as an entity, either a limited liability company or a limited partnership is a big expense. These legal counsel services can be charged between $50 thousand and $100 thousand. When forming the fund another step is to choose the type of registration, and a fund founder can choose between an investment adviser and a commodity pool operator structure.
After choosing the fund structure comes regulatory filings with overseeing regulatory bodies. Hedge funds are under the jurisdiction of the Securities and Exchange Commission (SEC). They require ADV filing from newly formed funds, which can cost between $10 thousand and $20 thousand.
Compliance costs fall into the bracket of constant costs that a hedge fund must cover annually. Figures in play are between $20 and $50 thousand.
There are also state registration fees that vary between states but are in a range between $2 and $5 thousand. Hedge funds also must report filings for each state where it will solicit investments. This is called a blue sky filing, and through it, hedge funds disclose their operations. These work as an anti-fraud law. It also comes at a cost, and in this case, it also varies between states in the range of $5 to $15 thousand.
To successfully fulfill all compliance demands from regulatory agencies hedge fund founder needs to hire compliance consultants whose services can cost up to $30 thousand. Depending on the state, and the company, there are more affordable options, that will take a smaller, $10 thousand bite from the founder's pocket.
These services are also a constant part of hedge fund operations and annually can cost between $20 and $50 thousand.
We cannot forget the initial setup of the risk management system and software. There are several options to choose from, like BlackRock Aladdin and Bloomberg PORT. This crucial element of the successful hedge fund setup can demand between $10 and $20 thousand.
Initial Operational Setup Costs
This part is pretty straightforward. A hedge fund needs office space and supplies. The heart of the hedge fund industry in the United States is concentrated in New York. Depending on the attractiveness of the location, renting out a suitable office space can easily go above the $20 thousand mark. If the fund is located outside New York, office space can be found much cheaper, even for $2 thousand per month.
If a hedge fund wants to create a sense of responsibility and seriousness it needs to design its space. Hiring an interior architect and filling the working space with compelling furniture can cost a lot. Talking about figures wouldn't be easy because they are triggered by preference. However, office supplies, utilities, and furniture can easily take $10 thousand from the start.
Adding to that figure are costs for IT infrastructure, which includes computers, servers, and networking equipment. Depending on the size of the fund, this is a highly variable figure but we can stick with $10 thousand.
Cost Of Personnel For Hedge Fund Managers
One of the crucial elements of every hedge fund is its personnel. Hedge funds demand top-notch investment professionals and those do not come cheap. Key personnel that every new hedge fund must count on are portfolio managers, analysts, compliance officers, and administrative staff.
While analysts are usually entry-level positions, their pay cannot be lower than $60 thousand annually. And this is talking cheap. More realistically, an analyst will cost $100 thousand. And these are only base salaries, without bonuses, which can be substantial.
Portfolio managers are next in the pecking order. Hedge fund managers have multiple roles, besides running investment portfolios. They are the showcase of a company, and prospective investors will for sure check who would be handling their cash. So, choosing reliable and experienced names will not only help in creating a successful investment process but will attract investors.
Depending on the name and all the benefits that come with it, a hedge fund manager can cost between $150 and $500 thousand per year. However, this figure can easily go up if the manager is known in the field.
Besides this base salary, there are bonuses for high performance that can multiply this salary. But, hiring hedge fund managers is an investment in the future, and splashing extra money could bring many benefits down the road.
Compliance officer is another crucial piece of the puzzle for every hedge fund. Since there are so many regulations, legal risks, and relevant laws that hedge funds need to adhere to, a CCO is a must. Their job is to monitor law and regulatory changes and to update internal policies.
Also, it is mandatory by the SEC for every registered hedge fund to have a CCO. The services of an average CCO will drain an additional $100 to $120 thousand per year.
And as a final piece in a new hedge fund puzzle, there are hedge fund administrators. They are often the heart and soul of the firm, and their often downplayed roles are keeping the hedge fund functioning properly.
An executive assistant or an office manager is a must in an every growing investment company. They operate as much more than a courier or a secretary, with help in organizing and keeping the schedule of often overworked hedge fund managers. And to be frank, almost every fund manager needs help from time to time.
Depending on the type of administrative worker, employees in this position can annually earn anywhere between $60 and $120 thousand.
Marketing Services
The marketing plan is often overlooked but is crucial for drawing potential investors and raising capital. A new hedge fund is starting at the bottom of a market that is already overpopulated and highly competitive.
A hedge fund should think about creating a unique, professional image. That combined with a viable strategy can draw prospective investors to start investing in the fund. A professional look includes a logo, overall visual identity, and business cards, combined with tear sheets and a pitch book.
Website is not a must, but since everything can be found online, it would boost funds visibility. Investing in a modern website with compelling information can draw additional investors' money justifying the investment.
Creating a brand identity, a website can easily cost up to $20 thousand, and even more, if the founder is aiming high. Best hedge funds have a distinctive look, which helps them draw accredited investors and raise their AUM.
Besides these fixed, and often one-time costs, there are annual marketing costs to include. In this bracket falls attending industry conferences, and keeping contact with the service providers. This is essential because after you create a compelling product you need to share it with the world. That involves a lot of networking.
This budget is completely open-ended and depends on the number of events the managers want to attend. Choosing wisely and opting for events that put in focus funds strategy, philosophy or approach is maybe to best way to start. As the fund grows, attending larger events, with bigger players is a must. In any case, a figure below $10 thousand wouldn't fit the bill.
Ongoing Administrative, Auditive, And Accounting Costs
We did mention some of these earlier, but we will repeat and group these costs in the same section. The costs vary depending on the AUM size of the fund, with larger funds paying higher costs. Most of the costs have two components - fixed and basis point fees.
For a fund with an AUM of $50 million annual administrative costs are divided into a fixed fee of around $40 thousand, while the basis point fee reaches $100 thousand.
Another component of annual fees is custodian and banking services. Custodians are crucial for funds operations because they are responsible for assets safekeeping, and transaction processing. For a fund with an AUM of $50 million custodian costs are in a range of $10 thousand for assets under custody, and transaction fees climb to $10 thousand, making a total of $20 thousand.
Banking fees for a fund of the same size are in the range of $6 thousand for account maintenance, and $5 thousand for transaction fees, totaling $11 thousand.
Acquiring data and research insights is crucial for every startup fund. It can be a decisive element that can push the fund into the right investment decisions that are timed precisely. Subscribing to research and data providers could generate returns that are not comparable with the costs of using them.
Depending on which and how many providers a hedge fund decides to apply to, the costs will rise. A conservative figure for a young fund is $10 thousand per year.
Final Thoughts
Starting a hedge fund is a difficult and risky journey. Hedge funds as an investment vehicle are risky at their core, and new fund managers must be aware of all potential downsides that can happen along the road. Attracting hedge fund investors is just one of the pieces of the puzzle, which comes after the fund has something real and of value to offer.
It doesn't come as a surprise that founders who invested more in the crucial elements of the fund's operations manage to create and maintain more successful funds. Making a judgment about where to spend more, in the beginning, could be a factor that would determine the fund's future accomplishments. So, when you put all figures on paper, think diligently before you start assigning funds.
