Starting a hedge fund from scratch is a difficult task. You need to fulfill several factors before you get to the point of raising investments. And that is the hardest part of this process. And in case you do not have any money, the toughest question is how to start a hedge fund with no money.
Before you register a hedge fund, you need to register as an investment adviser. Next, you need to choose whether you will form a domestic or offshore fund. You also have to form a service provider team that includes a lawyer, a fund administrator, and a broker. Another key decision is fund liquidity terms and fee structure.
Then you come to the question of developing a unique investment strategy. If it is properly developed it will set your hedge fund apart from others. The final decision is developing a compelling marketing strategy. After all these steps you can start thinking about attracting investors. The hedge fund industry is a very competitive playground, and to succeed you need to play your cards smart. Stay with us, while we go through the process of starting a hedge fund with no money.
Understanding the Basics
Overview of Starting a Hedge Fund
Starting a hedge fund is a challenging endeavor and it involves a series of considerations. It is difficult to define a clear way to start a hedge fund, but this is a basic path that you should follow:
- Define your investment strategy.
Show your investment plans and what sets you apart from the competition. That is the first stepping stone in landing investors. - Create a business plan.
Outlines your fund’s goals, target market, marketing strategy, operational structure, and risk management processes. - Choose a legal structure when registering.
Hedge funds are usually structured as limited partnerships (LPs) or limited liability companies (LLCs). Both offer investment liability protection to the owners. There are minor differences, so choosing an option is based on personal preference.
- Be compliant with regulatory bodies and their policies and regulations.
The Securities and Exchange Commission (SEC) is a regulatory body that is responsible for handling hedge funds and their operations.
- Set up the fund administration and base of operations.
That includes office space and hiring service providers. There are several services for which you can choose providers. You are not under an obligation to utilize all of them. If you want, you can keep some of the operations in-house. - Implement advanced technology into your strategy.
This is essential for today’s business and provides better trading and analyst performance. - Gather and build a strong team.
This is a big challenge for every new fund. Offer incentives for new analysts and managers. Set up a structure that is clearly defined, and where everyone knows its role. - Pay attention to raising capital.
Identify potential investors based on your strategy and their expectations. - Maintain investor relations and conduct transparent work.
Provide regular and transparent reports to the investors. This way you will build up long and strong relationships which are essential for your hedge fund.
Refining Investment Strategy and Results
Choosing and defining the investment strategy is based on the results and returns you want to achieve. An investment strategy is a set of rules and guidelines that will guide the fund in its use of capital for investing.
When choosing a strategy you are choosing the securities that you will invest in. Those can be currencies, bonds, stocks, fixed income, derivatives, or alternative types of investments. You will choose securities depending on the preferred strategy, goals, risks, and current marketing conditions.
When choosing a strategy and securities, you also have to mind the investment risk. The risk is also closely tied to the fund’s goals. What returns do you want to achieve? Do you want to invest in short or long positions?
All these factors will have an impact on risk. That is why managing risk is one of the most important activities when managing a hedge fund. The fund needs to articulate its risk tolerance, and what risk management techniques it will use.
Before you implement risk-controlling strategies you should identify and categorize risk types that can affect the fund. The most common risks hedge funds are exposed to are market risk, credit risk, liquidity risk, operational risk, legal and regulatory risk, and counterparty risk.
Also, you should evaluate the use of leverage as a strategy for gaining returns. Leverage as one of the strategies of boosting possible returns, can often backfire leading to massive losses. Using leverage should be carefully controlled by the risk committee. You should plan a limit on using leverage, and carefully select when you will utilize it.
There are other risk-controlling techniques like stop-loss orders, and stress testing that can lower the overall risk. Stress testing is conducted to evaluate the possible impact of sudden changes on the market that can impact the portfolio. The stop-loss technique is based on the automatic selling of securities when they reach an earlier set value. This way you can prevent large losses coming from single trades.
Setting Up the Structure
While setting up the structure of the fund you are making the most important decisions like:
- Choosing where the fund will conduct business
- What is going to be the structure of the fund
- How will you address liquidity and fee terms?
These factors will later prove to be very influential in the long-term success and attracting investors. You will never be able to come to terms with everyone, so carefully choose which way you want to go.
Determining Hedge Fund Structure
Domestic hedge funds are commonly structured as limited partnerships (LP) or limited liability companies (LLC).
In the LP the investment manager serves as a general partner in the fund. Other investors invest capital into the partnership. Based on those they receive interests. In either case, gains and losses are passed to investors based on their interest. Anyone who holds a limited partner role is a passive shareholder. While they are making the investments and supporting the business, they do not have an impact on management decisions.
An LLC exists as a separate entity from the owners. This legally ensures that the members in most cases cannot be held personally responsible for any business debts. This type of organization allows pass-through taxation meaning that the tax is not accounted for on the entity level. Members of the LLC still need to file a tax return if it has more than one owner.
Domestic vs. Offshore Considerations
Choosing to form a domestic or offshore hedge fund includes considering several factors. Those include regulatory guidance, tax implications, investor base, and operational flexibility. Some of the factors for choosing a domestic fund will make organizing and running it easier:
- Familiar regulations and legal framework.
When starting a domestic hedge fund you are dealing with regulatory bodies and legal frameworks you are familiar with. That makes complying with the regulatory requirements, and communication with the authorities easier - Attractiveness to the investors.
Less sophisticated investors will likely be drawn into investing with a domestic hedge fund. Potential investors are better acquainted with legal requirements and are familiar with the domestic trading market - Better access to service providers.
One of the founding elements of every successful hedge fund is quality service providers. Those include brokers, fund administrators, lawyers, and other legal aid. If the fund is locally located it is easier to find good service providers.
On the other hand, offshore registration can bring some unique features to the hedge fund management capabilities:
- Tax efficiency.
Different offshore investment locations offer zero or low corporate taxes. This feature can have a significant impact on the fund’s overall tax efficiency - Less burdening regulatory and legal framework.
Registering and maintaining an offshore hedge fund is often less encumbered by local regulatory requirements. They impose lighter regulations and do not require strict compliance requirements for regular hedge fund operations - Attracting a broader specter of individual investors.
Some specific, often major investors, prefer to invest in an offshore hedge fund. They are aware of the unique upsides and possibilities that these funds offer - Legal asset protection.
Depending on the location, hedge funds are protected by additional regulation. Some offshore locations offer legal protection to attract big financial companies. That way the hedge funds and their profits are legally protected.
But, although offshore funds offer their share of upsides they also carry specific risks:
- Complex regulatory environment.
Although regulatory bodies and requirements may be less strict, they can be difficult to navigate through. You would need to gather information about a specific offshore location or find an expert on offshore investment - Everyday operational complexity.
Working in different time zones, and very distant locations can be a burden for everyday work. That also includes finding dependable service providers. That can be a challenge without any internal knowledge about conducting business in that location. This can also impact on legal costs and administrative costs - Perception and reputation.
Offshore hedge funds have a specific reputation. That can be a turn-off for some potential investors. The main issues are transparency and due diligence.
Fee Structures and Liquidity Terms
Liquidity terms define when the investor can access the invested capital. Hedge funds that are focused on liquid markets and invest in exchange-traded securities can draw potential investors more easily. They need to offer favorable redemption intervals and reasonable lockup periods. It is crucial to find a balance between the availability of capital to the investors, and maintaining enough capital to work with all investments.
Different funds use different approaches. Some funds have long lockup periods. This is due to taking long positions that require time to increase in value. Other strategies offer more space and keep their lockup periods shorter.
The fee structure is another important factor for attracting investors. The hedge fund industry has a fee structure that has two components – management and performance fees. For long it was known as 2 and 20.
The management fee is 2% based on the assets under management. The performance fee is usually set at 20% and is based on positive investment returns. This means that the fund charges a fee for profits made by the fund above a certain predefined benchmark.
In recent years due to strong competition from new and old types of investment vehicles, hedge funds have been under pressure to reduce fees. For a new fund, offering lower fees for future investors would be beneficial. Also, it is not uncommon for hedge funds to offer shares to larger investors. That will not only bring an increased capital base but also enhanced visibility and credibility.
Overcoming Initial Challenges
Common Challenges in Hedge Fund Launch
Several challenges are major obstacles when starting a hedge fund. You need to navigate out of them if you want to run a successful hedge fund. To do so, you need to pay attention to:
- Following regulation.
Adhering to complex regulatory requirements is difficult, especially for a new hedge fund. If you plan on conducting work in several different jurisdictions, that is an additional challenge - Raising starting capital.
Raising capital is generally challenging. This is especially true for fund managers who do not have a strong investment track record. Building a strong value proposition, and developing a good marketing plan can help in these situations - Establishing operational structure.
This is a complex task that includes creating trading systems, organizing service providers, and risk management plans. If this process is not handled properly, it will lead to increased investment risk - Developing a capable team.
The majority of work in every hedge fund falls to data analysts and hedge fund managers. They work together in analyzing markets and investments. Identifying and attracting top staff is a big challenge for all brand-new funds - Implementing advanced technologies.
Sophisticated technologies are used in several hedge fund operations. To properly analyze data, and risk, and conduct trade, analysts and managers use these technologies. It is important to stay in the loop and follow any new technology development that you can exploit - Stiff market competition.
The hedge fund industry is by its nature highly competitive. There is a high number of already well-known and positioned hedge funds. Finding a place in that market is a very difficult task. You need to find something that will set you apart from the competition, and offer your hedge fund space on the market - Pressure to generate constant good performance.
Every hedge fund needs to constantly generate good returns for their investors. That is how they are keeping their investors, and attracting new ones. But, unlike larger funds new funds do not have any maneuverable space for mistakes. When starting you need to build up your position by conducting constant good work - Defining an accepting fee structure.
New funds have to balance out the level of fees so they can attract both the managers and the investors. First, you need to set those two in balance. Once you have funds to operate, you need to align the investment fees with the expectations - Maintaining liquidity.
Hedge funds are known as an investment vehicle with limited liquidity and access to funds. This is additionally based on the hedge fund strategies that the investment fund is using. You need to find a balance, so the fund has enough money to conduct trades and to attract investors. New funds with long lock-up periods are not a favorite options for investors - Adapting to marketing and economic conditions.
Changes in the local and global markets are constantly happening. These are external factors on which the fund does not have an impact. But, it must find appropriate ways to manage these situations. That is why it is important to conduct deep analysis and risk management before investing - Developing risk management strategies.
External factors are just one group of factors that can cause massive losses to the fund. The fund can develop and plan risk strategies to minimize possible losses. Managing risk is important for day-to-day work, and to maintain the fund’s reputation.
Take a A Look at How to Start a Hedge Fund with No Money:
Compliance and Legal Hurdles
When founding a new hedge fund, a hedge fund owner must navigate through a complex regulatory structure. These are the most common regulatory hurdles these funds must go through:
- Registering the fund.
If the fund is registered in the U.S. it needs approval from the Securities and Exchange Commission (SEC). If the fund is conducting work in other locations, you should examine local regulatory requirements - Filing ADV form.
This form contains information about the fund’s operations, investment strategies, key personnel, and potential conflicts of interest. The ADV form is filed to the SEC - Developing following compliance policies and regulations.
This includes several practices including anti-money laundering policies, following codes of ethics, and preventing insider trading - Verifying investor accreditation.
Investors need to be accredited before they can invest in a hedge fund - Developing cybersecurity measures.
Hedge funds deal with large amounts of sensitive information daily. This information is related both to the fund and to the investors. The hedge fund must employ policies and strategies to safeguard this information from cyber attacks - Complying with the Know Your Customer (KYC) procedures.
By following these procedures, the hedge fund is identifying the investor. This is done to avoid the possibility of money laundering, terrorist financing, and fraud - Conducting valuation practices.
Every hedge fund must have a fair process for determining the value of the investment. This is especially applicable to funds that trade in illiquid or hard-to-value securities.
It is always advisable for new hedge funds to hire a legal professional with extensive knowledge of securities law, and fund formation. We also recommend advising the legal aid about any new regulations or their changes. It is also advisable to keep open communication with the regulatory bodies. Following through with their recommendations and regulations will help in developing a healthy business relationship.
Capital Raising and Investor Commitment
Raising the first capital and gaining the first investors is like setting a foundation for future business. To do so you need to combine credibility with communication and a dependable investment strategy. When approaching the investors you must have a well-thought-out plan. With it, you must show how you plan on meeting their investment objectives while minimizing risk.
It is also important to build, develop, and maintain a relationship with your investors. That is the key to forming a fund that will last. To do so, you need to earn investor’s trust through transparent work that brings positive returns.
Marketing and Raising Capital
Defining a marketing plan is essential for attracting larger amounts of capital. Through this process, you are determining your target investment group. Based on that you can develop a pitch strategy to lure those investors.
Crafting Marketing and Pitch Strategies
Creating a good marketing plan and appealing pitch strategy is an important part of starting a hedge fund. They will be an important method of gathering the first major investors. With the fund marketing process, you need to present your strategy, and why an investor should choose you. This is a recommended to-do list when crafting a marketing plan:
- Articulate and present your investment strategy.
Show the potential investors your trading strategy, and what sets it apart from other funds. In the end, the strategy is what will keep the investors with the fund - Create a unique pitch deck.
A properly defined pitch deck should show the key information about the hedge fund. In it, the hedge fund owner presents the hedge fund’s capabilities, the credentials of the fund’s team, and ways of managing risk. Find an easy and compelling way to present your case. To do so, use visuals, and charts to make things approachable and transparent - Identify the investor sector that aligns with your fund’s strategy.
This way you can conduct target marketing campaigns that have a higher chance of success - Establish an online presence.
Create a website that will present detailed information about the fund and its key staff. Use social media and other online platforms to build your hedge fund’s name. These channels of communication are also great for finding and communicating with potential future investors - Build a business network.
Use all potential possibilities for networking. The most common are industry conferences and events. Through them, you can even further build your influence by meeting industry professionals. These events are also a good way to identify possible investors.
Understanding Value Proposition and Target Market
The value proposition is a set of benefits and advantages that your fund offers to the investors. Understanding the value proposition is one of the most important prerequisites for attracting investors. It is also crucial to differentiate your fund from the rest of the market. This way you are defining your target market.
To properly understand the value proposition you need to define the following:
- Investment strategy and what sets it apart from the market
- Approach to risk management
- Approach to Transparency
- Fees and what the investors get in return
- Emphasize any unique access to investment or any liquidity feature that is different than in other funds.
When you know your value proposition you can move to identifying your target market:
- Identify specific investor segments.
Your target market can be individual investors, family offices, institutions, or other groups - Risk tolerance.
Once you know your investor target group you must identify their risk tolerance. Create your marketing messages so they are in line with their risk appetite - Learn their objectives.
This will often have an impact on your investment strategy - Identify the level of investment.
When you know how much money your target group is willing to invest, then you can form your minimum investment threshold - Find a way to your target investors.
There are several ways to reach your target market. You can directly approach them, or through financial advisors or institutional consultants.
Organizing Marketing Plans
Building for the Future
Developing an Attractive Hedge Fund Structure
When developing a fund structure you need to think about the long-term plans. It is important to create a balance between meeting the needs of the investors and aligning with the strategy of the fund. All this should be followed with minding on all regulatory demands.
A well-built fund structure cannot function without competent employees. You can release the maximum potential of hedge funds by hiring both legal and financial professionals. A well-formed investment staff will ensure that the fund is appealing and compliant to potential investors. Some of the methods you should also utilize are:
- Attracting different investor classes
- Offering free waivers and discounts for early investors
- Optimize tax efficiency for both the investors and the owner
- Conduct investor education so the potential investors can understand the broader hedge fund picture
Attracting Institutional Capital
To attract institutional capital a hedge fund needs to develop a strategy that will address the specific needs and preferences of these investors. These investors are grouped into pension funds, endowments, foundations, and family offices. They are known for different due diligence processes and criteria when compared to individual investors. These are key takeaways for attracting institutional capital:
- Support robust institutional quality infrastructure.
This includes demonstrating the implementation of new technology, and risk management systems, and following compliance procedures. - Have a transparent investment process.
How are investments chosen? How the actual investment is conducted? This process is important for all major investment institutions. - Offer customization options.
Among the most popular are separately managed accounts or tailored investment mandates. These offer institutions a personal touch when choosing investments. It is also a good idea to align the investments with the goals of the institution. - Modified fee structure.
Offer better terms for larger institutions, or long-term partnerships.
Building an Institutional Quality Hedge Fund
Building an institutional-quality hedge fund requires detailed planning and a focus on operational excellence. Also, the factor of success includes meeting often high standards that these institutional investors have.
Be in contact and learn from industry professionals. Always work on improving your investment strategies. These are the best methods to attract potentially larger institutional investors.
Ensuring Operational Excellence
Importance of Service Providers and Independence
Service providers like fund administration, accounting, and legal aid have a significant impact on the day-to-day operation of every hedge fund. The importance of service providers is reflected in these reasons:
- Operational efficiency.
Service providers allow hedge funds to outsource all non-essential functions to a third party. This permits hedge funds to focus on their most important functions like investment and risk strategies - Independent risk management.
There are service providers that offer professional risk management. This can help in identifying and mitigating operational, legal, and compliance risks - Professional regulatory providers.
These providers are always in the loop regarding the newest regulatory codes. This helps hedge funds to stay on top of the ever-evolving regulatory practice - Improved economies of sale.
Utilizing service providers is usually cost-effective when compared to organizing these services in-house.
Selecting Key Service Providers
Once you know what service providers can achieve you need to know how to choose them. First, you need to know what types of service providers are essential:
- Hedge fund administration.
They are handling administration tasks like accounting, NAV calculation, and regulatory reporting - Prime brokerage.
A prime brokerage firm is designated to handle trade, clearing, and custodial services - Legal counsel.
When choosing a legal aid find those that have ample experience in working with hedge funds - Auditing firm.
Hire an auditing firm to conduct independent annual audits. That way the fund is covered regarding assurance on financial statements - Technology providers.
Choose a technology provider with a trading background. They will also cover risk management systems and other tech needs.
When you decide what service providers you will use, you need to know how to select them. There are two most important factors when identifying service providers:
- Industry experience.
The first thing you should check is the provider’s track record and experience in working with hedge funds - Reputation.
Before you hire a company, ask professionals from the industry about their experience with the company. Try to identify their reputation in the industry.
The service provider needs to comply with the regulations and also have expertise regarding those regulations.
- Regulatory expertise.
Service providers must be in regular touch with hedge fund regulations. That is essential for keeping your fund in compliance - Legal compliance.
Inspect is the service provider in compliance with relevant regulations and standards.
One of the most important factors when choosing a service provider is independence and objectivity in their work:
- Providers independence.
Check that the service providers, especially auditors and councils maintain work independence. This is important for avoiding conflict of interest - Objectivity in work.
You should choose providers that can offer objective assessment and advice
Next in line is checking the fee structure:
- Transparency of cost structure.
Evaluate the fee structure of the provider. Try to go a step ahead and identify any possible hidden costs - What you get for what you pay.
The cost of the provider is not the most important factor. Check what you will get for your money
Another method of developing the fund is by hiring the right service providers. If they have a well-developed business network you can use it to your advantage:
- Connections in the industry.
Utilizing a provider with connections in the industry, you can find top talent or potential investors - Collaboration between providers.
If the providers have collaborative relationships that can help them in doing business smoother.
These are the most important factors when evaluating service providers. When choosing do a deep background check, and look for recommendations. See if their goals and strategies are aligned with yours. The goal is to have a long and strong relationship with the service providers. Their help will be essential for developing operational infrastructure and setting your hedge fund in the right direction.
FAQs
Can Anyone Start a Hedge Fund?
In theory, anyone can start a hedge fund. But, the process of starting a hedge fund involves several steps. A potential hedge fund owner needs to make several considerations and must fulfill certain regulatory requirements. These are the most important takes on starting a hedge fund:
- Compliance with regulations.
It is essential to comply with the regulations both when starting, and while managing the hedge fund. In some jurisdictions, hedge funds are under close oversight of relevant regulatory bodies. The hedge fund must navigate through them when registering and licensing the fund, and following the securities laws. These laws vary from jurisdiction to jurisdiction - Legal structure.
Choosing a legal structure is essential and will have an impact on regulatory compliance, investor protection, operational efficiency, and liability considerations. Hedge funds are commonly organized as limited partnerships (LP) or limited liability companies (LLC). These legal structures limit the liability of fund managers and investors. They allow the separation of personal assets from the fund’s liabilities to help protect investors - Gathering starting capital.
To start and operate a hedge fund an owner must pool significant starting capital. The amount needed depends on the strategy of the fund, regulatory requirements, and overall operating costs. The starting capital is usually a mix of the owner’s capital, with the capital of the family and friends - Experience in the finance sector.
Although this is not a formal requirement, knowledge and experience from the trading and investment world are beneficial. Potential investors are always checking the background and track record of the owner and the portfolio managers - Developing a business plan.
Designing a sound business plan is crucial in attracting new investors. The plan should profile the investment strategy, target markets, risk management strategies, and return projections - Developing the fund’s infrastructure.
This includes choosing and hiring service providers and establishing the necessary infrastructure for trading and risk management.
Can I Start a Hedge Fund with My Own Money?
Yes, you can start a hedge fund with your own money. Often hedge fund managers and owners use their own money to start a hedge fund. This process is called seeding the hedge fund. This is a good approach to starting a hedge fund if you have a proven investment track record. But, before you start this endeavor create a detailed plan and get advice from an experienced professional.
Is Starting a Hedge Fund with Friends A Good Idea?
Starting a hedge fund with friends can be a good idea, but it has its share of possible problems. We will go through the most important advantages and drawbacks of this concept.
Advantages:
- Similar vision and business goals.
If you share the vision and goals then it will be easier to work together - Trust and ease of communication.
Starting a business with friends automatically brings a level of assurance into the project. It will be easier to talk about the vision and ways to reach the goals - Combining resources.
Starting a hedge fund with friends means that you can pool more starting money. This is especially important when starting a fund because finding the first investors is the most difficult task
Drawbacks:
- Putting pressure on a friendship.
It is one thing to be friends with someone, and completely other to invest the money together. In case of high-pressure and risky situations, this can be a serious issue even for a long friendship - Difference in expectations.
Although you may share the same values and goals, the way you must take to reach them can be very different. It is important to define a strategy before starting this type of project - Challenging exit strategy.
Planning an exit strategy in case of a big loss can be a strain. You and your friends can have a different view of things, and this can slow down an operation that demands quick acting.
Before you start this project have a serious talk about defining roles, responsibilities, and expectations. Keep the communication transparent and regularly discuss hedge fund performance. Always keep in mind that you are running a business, and establish boundaries between professional and personal relationships.
Final Considerations
Starting a hedge fund without any money is a difficult and risky operation. If you have some know-how, and you are an ambitious person you can just make it work. It is important to know what your goals are and how you want to achieve them.
You should start by identifying your investment strategy. From there you can identify possible investors. You and investors need to be on the same page regarding goals and means to get them. To avoid bad performance you should do a talent search for capable fund managers and analysts.
To get impressive returns it is recommended to outsource all non-essential operations to the service providers. They will help you to focus on creating operational infrastructure and doing your primary mission – investment. Once you complete all these steps you have a chance of making it in the ever-competitive hedge fund market.
