How do I start and sustain a successful hedge fund?

September 30, 2010 8:06 AM

How do I start and sustain a successful hedge fund?

Hi!

I plan to start my own hedge fund sometime in the future. Can someone tell me what I need to learn and do to get started?

I have a strong technical background and am comfortable with technology.

Offhand, I think I am missing the following expertise.

a) risk management

b) valuations

c) trading

d) law

I need insights from the hivemind on,

i) which other expertise areas am I missing?

ii) how to efficiently and effectively acquire expertise and knowledge in my deficient areas.

For some background,

1) I have a PhD in computer science, my research work centered on artificial intelligence.

2) I recently began working in Risk Management technology at a big-bank that survived and thrived in the great recession. This is my attempt to get in on the ground floor to learn about risk management.

3) I have begun studying for the CFA exam (level 1).

More background...

a) I am skeptical of most high-frequency trading, i.e., hedge fund-wannabes that seek alpha(gains) by collating ever so closely with stock exchange computers to reduce latency.

b) I am a big fan of the book Margin of Risk

Thank you! :)

posted by jchaw to Work & Money (15 answers total)

There are programs that teach this; for example: http://www.qcf.gatech.edu/.

But I'm with millipede...somewhere you're going to need to come up with very large buckets of money. That's probably the hardest part.
posted by kjs3 at 8:29 AM on September 30, 2010

You're going to need lots and lots of money.

First, you're going to need to incorporate and be careful here, you're structure will define how you and your clients are taxed. You'll need some good legal work and a corporate agent. Most hedge funds are probably LLCs or LPs offshore (Cayman Islands), but there are some that are in Delaware (which would most likely be a cheaper and easier option). The legal fees would probably be at minimum $10,000 upfront if you did it right, the corporate agent would be about $1,000 per year. You will also be expected to keep a respected law firm on retainer. This will be minimum $10,000 per year even if you do zero work with them. More likely, each and every client will have some weird problem that will require you burn some legal hours. Expect each hour to cost at least $500.

Second, you're going to have to convince people to work for you. I am assuming you have no track record so you are going to have to over pay/ or hand over future earnings/ownership in some way. I am in a related industry and I'm not sure I'd go work for someone with no history in the business for even 2x my current compensation. You'll probably get people either fresh out of school that do not have better options. You'll want at least one lawyer and one accountant on staff, plus a couple analysts.

Third, you will have to look into registration requirements in your jurisdiction. You will probably be able to avoid SEC registration initially but the rules are changing and becoming more strict. I am not up on SEC requirements at this time, but you used to be exempt if you were under 14 analysts and $25 MM in assets.

Fourth, you will have to convince people to give you money to invest. If you can do this, you deserve to be a billionaire. Plenty of good established firms can't do this at this time as people are scared or overly cautious. To do this, you will have to succinctly describe your company's investment strategies, and also be aware of other strategies so you can compare them on the fly when asked.

Fifth, it's going well and you're off the ground! Just report your earnings as you promised you would and hope the returns outpace your HF competitors!
posted by 2bucksplus at 8:34 AM on September 30, 2010 [1 favorite]

"Starting a hedge fund" isn't a valid goal. A hedge fund is basically just a compensation arrangement. You need to become passionate about investing and figure out why people should pay you to manage their money.

Focus on your new Risk Management job and become the rock star of that group. When opportunities arise to get closer to or on the trading floor, jump on those.
posted by mullacc at 8:38 AM on September 30, 2010 [1 favorite]

So you love Seth Klarmann and call valuation and risk management your weaknesses? Ok then. Listen to what Mullacc says.

Also fund raising in equity long/short funds is dead even for guys who have a clue and a track record.
posted by JPD at 8:45 AM on September 30, 2010

Also risk management at a fund (especially one inspired by Margin of Safety) is utterly and totally different from risk management at a bank. Like not even remotely related.
posted by JPD at 8:47 AM on September 30, 2010 [1 favorite]

Gosh not to discourage you, but a strong IT background and beginning to study the CFA programme won't help YOU attract capital. 'Cause that what you are selling when you try to raise money.

I used to run client money and while 2bucksplus makes some very good, very general points there are lots of specifics that are going to cause you problems.

First, what trading experience do you have? Under what market conditions and which asset classes? Clients will want to see audited numbers as well, and size matters, so forget about showing someone your exception IRA performance over the past three or four years. If you're looking to run $100M then you better have had experience working with $100M or thereabouts.

Second, what's your market view? That will dictate the type of fund you establish (i.e., event drive, market neutral, global long, etc).

Third, what type of compensation structure and client lock in periods are you entertaining? The old days of fees funning at 2+20 are probably long gone, and since you'll just be starting out you'll probably have to be prepared to work for nothing just to raise capital. Can you?

Fourth, what presence do you have in industry? You mention a Phd in Computer Science (great), but what have you done in finance? Working on the technology side in Risk Management is a big difference from sitting on a trading desk, or writing regular market commentary which might entice clietns to give you a little cash to manage.

We could go a little deeper, but lets see how these questions pan out first.

If you are serious about starting a hedge fund - and with your background - I'd recommend doing whatever it takes to get hired at one, and learn the business from the inside out.

On preview: mullac and JPD are spot on. Focus on your new job first ...

I see from your profile you're in New York; if you were in London we might have been able to do something, as I'm actually recruiting two Quantitative Analysts right now for a buddy that runs a small global macro fund. Very shitty (seriously! as in ZERO) pay & very, very long hours but you'd be learning the business from the inside. If they make money you'd make money, but whomever they hire is working for zilch for a year. Sign of the times, lots of bodies on the street & few openings in fund management these days.

posted by Mutant at 8:51 AM on September 30, 2010 [2 favorites]

There was a post a while back on MeFi about a guy who loved loved loved finance. Reading financial docs was his thing. He was however either a nurse or at med school. But every night he used to post on his blog his analysis and recommendations.

Eventually, he decided to try and start a fund. Raising capital was easy, because various movers and shakers had been reading his blog and seen that had he had money at the time he was analysing etc., he would've made bucketloads of cash.

So yeah, if you've got no money, at least put your thoughts out there so that in future people will have some idea who you are etc.
posted by djgh at 9:04 AM on September 30, 2010

all you need is the above, plus half a billion dollars.

Hate to break it to you but the securities laws are complex and arcane. This lawyer guesses you would need $200,000 in legal work just to start the thing.

I'd just work for someone else's hedge fund. Because the hard part is getting people to trust you with millions and millions of dollars. If you're asking AskMe about it, you have a long way to go.
posted by Ironmouth at 9:06 AM on September 30, 2010 [1 favorite]

Also, anything Mutant has to say regarding finance should be tatooed on your arm
posted by Ironmouth at 9:09 AM on September 30, 2010 [1 favorite]

djgh: "There was a post a while back on MeFi about a guy who loved loved loved finance. Reading financial docs was his thing. He was however either a nurse or at med school. But every night he used to post on his blog his analysis and recommendations."

I believe you're talking about Michael Burry, one of the principal characters of The Big Short and the subject of this FPP.
posted by mkultra at 9:16 AM on September 30, 2010

Mutant is correct.

Also, very few hedge fund people have the CFA designation. It's not really relevant to the world of hedge funds.
posted by dfriedman at 9:20 AM on September 30, 2010

Also, very few hedge fund people have the CFA designation. It's not really relevant to the world of hedge funds.


you are absolutely wrong.
posted by JPD at 9:23 AM on September 30, 2010

Mod note: Several comments removed. Either take a breath and substantiate your opinion or let it drop. Take the U, NO U stuff to email if you have to.
posted by cortex (staff) at 9:50 AM on September 30, 2010

The CFA is absolutely relevant to the world of hedge funds, especially the type of hedge funds inspired by the author of the book the OP cites.

Most HF guys I know aren't CFAs, but that's because most of the people I know were fellow analysts at a big investment bank. We had training that covered similar material and then learned on the job. Some of those people pursued the CFA anyway.

More importantly, everyone I know in hedge funds, long only firms, private equity firms, sellside research and I-banking all think a CFA is a very valuable designation.

The OP asked about hedge funds specifically. But that's just a sign of the times. The OP wants to be an investor and that means the CFA is worthwhile. Especially for someone with no finance background.

Many investors say the CFA is more valuable than an MBA too (I agree with the caveat that going to a brand name school has real advantages).
posted by mullacc at 10:12 AM on September 30, 2010

I'd suggest trying to do things on a smaller scale via a website like kaChing. Create a track record and amass some capital.

I work in the industry and today's game is much harder to get into than just a few years ago. You've got to bring skin in the game (i.e. at least tens of millions of dollars of your own money) and a track record to get any type of capital commitment.

If you can demonstrate great alpha for an extended period of time, it will be the best way to deal with both fundamental issues (skin and rep).
posted by Hurst at 1:38 PM on September 30, 2010