Hedge fund managers are some of the richest people in the United States. People like Ray Dalio, Ken Griffin, and Michael Platt have made billions of dollars by just investing in the stock market. While some of the richest hedge fund managers avoid the limelight, some of them like to show off. Recently, Griffin made headlines when he purchased an apartment for more than $230 million. Bill Ackman too bought an apartment for more than $100 million. Therefore, many people would want to start their own hedge funds. In this article, I will explain how you can start a hedge fund today.
- 1 What is a Hedge Fund?
- 2 How Hedge Funds Make Money
- 3 How to Start a Hedge Fund
- 4 Final Thoughts
What is a Hedge Fund?
A hedge fund is a simple company that collects money from outside individuals and companies with the goal of maximizing their value. The hedge funds then use these funds to invest in the stock, currencies, ETFs, and commodities market. The companies benefit when their investment returns rise in value. According to Barclay Hedge, the total assets under management in hedge funds are more than $3 trillion.
“Look at those hedge funds – you think they can wait? They don’t know how to wait! I have sat for years at a time with $10 to $12 million in treasuries or municipals, just waiting, waiting…As Jesse Livermore said, ‘The big money is not in the buying and selling…but in the waiting.'” ~ Charlie Munger
How Hedge Funds Make Money
Hedge funds make money in two ways. In most cases, the funds use a 2/20 method of generating returns. The 2% refers to the administrative fee that they charge their customers per annual. This fee is used to pay leases, pay the employees, and other things used to manage the funds. The 20% is known as the incentive fee. This is a fee they charge depending on the profit they make. A good example of this in action is this.
Assume that you have a fund with $10 million in assets. This means that you will first make $200,000 in administrative fee. If your firm returns 20% in a year, it means that the fund’s profit will be $2 million. Your 20% incentive fee will be $400,000. This means that your total income for the year will be $600k. As a result, most hedge funds generate millions of dollars every year.
How to Start a Hedge Fund
Starting a hedge fund is not an easy thing. You first need to have several skills and expertise to be a successful one. Some of the traits you need to have to be a successful hedge fund manager are:
- You must have a proven track record in managing money.
- You must have a good understanding of how the financial market works.
- You need to have an excellent risk management strategy.
- You need a long-term view.
Start a Hedge Fund Step 1: Get Some Experience
The first step you need to follow when starting a hedge fund is to gain some experience. If you have an education background in finance, a good way to go about this is to find a job at a hedge fund or an investment bank. The goal of this is that you want to have some knowledge about how the industry works. Another advantage is that working at a credible location will help you create a reputation in the financial market. You will use this reputation when it comes to raising money. You will also find likely hedge fund partners in this organization.
Start a Hedge Fund Step 2: Create and Furnish Your Strategy
As you work in this organization, you should be thinking about the strategy you will use to invest the clients money. This involves a number of things. For example, you should look at the type of investments that you want your hedge fund to specialize on. Some types of investments are stocks, commodities, ETFs, index funds, and currencies. In addition, you should consider the type of investment strategy you want to follow. Some of the most common hedge fund strategies are:
- High frequency funds. These are funds that use complex algorithms to initiate and execute trades. You need to be excellent at software development and AI to succeed in this. Examples are Renaissance Technologies and Citadel.
- Activist investor. These are funds that take positions in companies and advocate for changes. Examples are Pershing Square Capital and Greenlight Capital.
- Balanced funds. These funds invest in both stocks and bonds.
- Long/Short funds. These funds invest in companies they believe will move up and short those that they expect will fall.
- Special situations. These funds invest in special situations such as when there is mergers and acquisitions and divestitures.
- Multi-strategy. These hedge funds use various strategies to invest in the market.
Start a hedge fund step 3: Start Small
After coming up with a strategy and testing it, you should now start small. In this, you should register your fund and start investing with a small amount of money. Ideally, you should start with your funds. Additionally, you can raise additional funds from people close to you. Examples of these are your family and friends. The goal of this step is to prove yourself and to your investors.
Most hedge funds start like this. David Einhorn started Greenlight Capital with less than a million dollars. Today, the fund has more than $5 billion in assets under management.
Start a hedge fund step 5: Grow
After spending a year investing in your fund, now is the time to grow. This is a step where you start raising money from big investors. Since your network is relatively small by now, the best process is to use the current investment banks. These banks have a large network of clientele. They will refer you to these institutions, where you will pitch your firm, your performance, and strategy. If you do your presentations well, it will be possible to raise a lot of money.
Start a hedge fund step 5. Be Accountable
The final step of starting a hedge fund is about being accountable. Your investors want you to be as honest as you possibly can. Hedge funds do this by sending regular investment letters to their investors. You can send to them a letter every month or every quarter. The letter will describe the investments that you made, the reason for making the investments, and what you expect in future. You should try to be as honest as possible.
Starting a big hedge fund is a relatively complex thing. Still, this is the best process you need to do to start such a company. You need to learn the benefits of starting small, being consistent, and being honest. Honesty is important because, many hedge fund managers who fail do so because of their dishonesty. A person like Bernie Madoff became a crook because he did not tell his investors that he had underperformed the market.
Crispus is a finance professional with more than a decade experience in the industry. Over the years, Crispus has written in-depth articles on leading platforms like CCN, Marketwatch, and Seeking Alpha. He also runs a Forex education and managed account company called WestEndFx.