If you are looking for a more aggressive investment vehicle, then starting a hedge fund might very well be the next best step you need to take. With over $3 trillion currently being managed globally, hedge funds are a great way to stay ahead of the pack and leverage new and alternative markets.
If you are relatively new to the concept of hedge funds, this article will provide a quick look into how to start a hedge fund today. But first, let’s take an in-depth look into what a hedge fund is.
Hedge Fund Definition
A hedge fund is money pooled together by a private limited partnership and managed by a professional portfolio manager to make higher returns. Hedge funds are like investment vehicles that involve two sets of people: a group of investors who leverage their finances together as one and a professional portfolio manager (also called a hedge fund manager).
What is a Hedge Fund Manager?
A hedge fund manager is a professional trader who manages the investment pool of investors to create profit at a much higher stake. Hedge funds are called alternative investment vehicles because the structure, stakes, and investment opportunities do not follow the regular investment structure.
You may wonder what makes hedge funds different from a mutual fund investment. While mutual funds are generally open to the public, hedge funds are not.
Mutual funds invest only in publicly traded stocks with the lowest possible risk, and they typically have a low return on investments. Hedge funds, on the other hand, are private investments, and only accredited investors can join a hedge fund.
With a hedge fund, you can invest in anything and everything. Hedge funds aim for a higher return on investment, so they invest in many high stake portfolios. The flexibility of hedge funds and the high return possibility make investing in them a viable plan.
Also, investors do not have to worry about tying their money down in an investment for years, as most often seen with mutual funds. A hedge fund’s investment strategy could hold for seconds to years, as the case may be.
But on the downside, the risks are pretty high, and the fees charged by the investment managers are higher than what mutual funds charge.
How Does a Hedge Fund Work?
A hedge fund typically needs a portfolio manager whose first job is to source and raise the necessary capital for the investment from investors. Once an agreement is made on the profit sharing and the strategy, the portfolio manager then uses the sourced funds to make the investments agreed upon.
As mentioned before, there are no limits to what a hedge fund can invest in. A hedge fund can invest in various types of securities, including well-known stocks and bonds, as well as more sophisticated and exotic financial instruments.
When the return on investment is made, the dividends are shared mainly on an 80-20% basis. Where 80% goes to the investors, and 20% goes to the manager. This makes the hedge fund manager’s salary quite attractive.
The hedge fund manager uses investors’ finances as higher leverage to make bigger profits for all the parties involved.
Pros & Cons of Starting a Hedge Fund
Investing in a hedge fund requires an investor to have a net worth of over $1 million because of the high volume of finances necessary to pull it off and the risks associated with it. There are several reasons why starting a hedge fund would be a profitable venture.
For one, you would be leveraging the funds of investors to capitalize on great markets and investment opportunities with great profit returns for all. Even though the securities and exchange commission still regulates hedge funds, they have a lot more space and freedom compared with other types of investments publicly available.
Also, hedge funds are designed to make profits whether the market is doing well or not. You can consistently have a solid profit base by running a hedge fund. But like every other business venture, hedge funds have their risks.
Not all hedge funds are successful.
4 Steps for Starting a Hedge Fund
As explained earlier, hedge funds involve a lot of risks, but there are ways you can start a successful hedge fund that will benefit your business over a long period.
Step 1: Raise Capital
Naturally, your first step will be to source the capital needed for the hedge fund. There are few people who would give their money to a newbie manager or new firm to manage.
Money goes where it is trusted and somewhere with proven results. Since you are just beginning, building a credible profile may not happen immediately.
But you can improve your credibility through your results. Be able to show how much you have made and can make with the money you do have now.
This money can come from several sources, including your personal funds, family and friends, grants, and business seeders. What you can do with the capital at hand tells potential investors what to expect when they entrust their money to you.
How much money do you need to start a hedge fund? The figure varies from $50,000 to $100,000.
Step 2: Set up the Legal and Corporate Structure
When you have sorted capital and financing, the next step is to structure the hedge fund on a corporate and legal level. Register with the securities and exchange commission as your next step. Set up the articles of incorporation for the hedge fund and file them.
Fulfilling all the necessary legal and corporate requirements is essential. This step shows investors and potential investors that you can be trusted, and that your investment structure will stand the test of time.
Also, registering with the IRS is very important both for you and for the potential investors. There are also hedge fund managers who have experience preparing the legal paperwork required to start and run a hedge fund.
They are not cheap and may most likely cost top dollar. But one advantage of bringing them in, is the wealth of experience and clients they often have.
Step 3: Acquire a Hard Working Team
A single person, even with a great idea and strategy won’t be able to pull off a hedge fund successfully. Choosing who works for you is critically important.
You want to have a strong and firmly knit team who understand how important it is to protect the information you work with. You also want a team that is not just qualified but equally ready to do the work and go the extra mile in getting things done.
Your team is an indispensable aspect of the hedge fund.
Step 4: Establish a Strategy
Establish the model of operations the hedge fund will use. Hedge funds have several strategies and investment structures that are available, especially for different markets and securities.
You want to outline this clearly both for your team and the investors who will be working with you. The effectiveness of your strategy will determine how profitable the hedge fund will be.
Decide how long you plan to go with this strategy. Is there room for flexibility and change?
Go Over the Hedge
Hedge funds are an excellent way to make great returns on markets using a more aggressive approach. Starting a hedge fund puts you in a strong position to leverage pooled funds to earn higher returns.
Do diligent research before taking the deep dive. Financial advisors will also be an indispensable tool to help you understand how hedge funds work.
They can also help you set up your hedge fund faster and more effectively.