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How to Start a Hedge Fund

Date: Tuesday, August 21, 2012
Author: Jesse Marrus, OnWallStreet

Starting a hedge fund is much different from launching other kinds of companies. Most significantly, there is almost no chance that you will be able to start this business out of a garage. No -- to get a hedge fund up and running, you need buckets and buckets of cash.

"If you really wanna succeed, and you wanna manage a higher level of assets, out of the gate it takes you eating your own cooking," said Mitch Ackles, President of the Hedge Fund Association and CEO of Hedge Fund PR. "What that means is you have to have some of your money invested at the outset. We're not talking $500,000 -- it has to be several million."

Ackles told StreetID that smaller launches tend to fail. "Let's say you and I were to get together and launch a hedge fund with $10 million, we would probably stay at $10 million," he said. "Raising assets, unless it's from a very wealthy individual, will be very difficult. No institution will look at a fund of that size. So you have to have at least $100 million out of the gate. That means money that is committed, which is called seed capital.

"So let's say I worked at a prop desk at Goldman Sachs. I may have people that are my contacts and they liked the strategy that I employed at that prop desk. While I may not be able to look back and say, 'This was the track record I had,' because this was the property of Goldman, they might know my pedigree, they might know my capability. I can say, 'Look, this is the strategy I'm going to employ.' It's kind of like being first in line at an IPO. There are a group of people that will be seed capital providers. What that means is usually going to your Rolodex first. Who do you know that's a wealthy individual. Even a small endowment or foundation or even a smaller institution."

If you are wondering why someone would provide money to an unproven fund, Ackles said that it's because of the advantages in being the first to jump on board. "You negotiate a deal where they get reduced fees," he said. "So they pay less than the investors that come after them, so they get a sweeter deal."

Launch Time

"Then after that I've got my $100 million and I launch," said Ackles. "What it takes next is me creating the actual business, just like you and I would do for any [other business]. So I need to have the infrastructure; I need to pick a place for an office, I need to hire a team."

That team could come from a bank if your hedge fund spun off of one. "It might be a portfolio manager at the top, but there are traders that work with him," said Ackles. "And perhaps others -- a compliance person, a legal person. You have to hire people."

Next up: acquiring Bloomberg or Reuters terminals or whatever else you may need to take on the strategy. "After you've got it in place and you begin trading, you need the pieces to market the fund," said Ackles. "So you need a pitch book, which is essentially a PowerPoint presentation that conveys your investment thesis that explains in detail your view on the market, what your strategy is about, why you believe you're able to execute it, and who are the people that provide services to your firm."

For better or worse, investors will want to see some big names attached to your fund. "Having [big names] is essentially showing that you are quality enough that they took you on as a client," Ackles explained. "So you need the service providers, and it's an administrator, an auditor, an accountant, a prime broker, and those types of people will give you further credibility."


"Many people will need to have a software system online or installed locally that will allow them to benchmark their performance," said Ackles. "So if you and I were to invest in Vanguard, there would be a performance sheet that we can download that would show how well the performance of that fund did versus the indices it's benchmarked against. It will show a brief commentary on what the manager thinks about what's going on in the performance and what's going on in the overall economy. It will have other sorts of data points that might be able to help you evaluate qualitatively the performance of that fund."

Ackles said that a hedge fund is no different.

"You may launch and you may have seed money, but it may be a year or two before outside investors want to come in because they really want to see a track record," Ackles warned. "They want to see consistent performance. And they want that benchmark that you're navigating against or that performance measure to have meaning, and it requires a certain number of data points for that to become meaningful."

Ultimately, Ackles said that technology goes beyond a hedge fund's performance reports.

"Just like you and I, they need backup systems and redundancies and things that are more infrastructure-related to their technology," he said. "They need to have insurance. This is a big one that a lot of people don't know about. You need to have specific insurance in place -- not only health insurance for your employees if you want that perk in place to attract the best talent -- but you have to have insurance on the managers."

Though no one wants to think about the worst-case scenario, it is important for you to ask yourself, "What if the manager dies in a plane crash? What if the manager is 70 years old and then retires?"

The answer to those questions is why insurance is so important.

Raising Capital

"Let's say you've got all of those pieces," Ackles continued. "Now you need someone to help you raise the money. While an investor wants access to the portfolio manager, the portfolio manager has the day job of watching the trades. Typically they will hire marketing people, so there's going to be someone in-house or external that is charged with bringing investors to the table."

Managers still have to come to the meeting, Ackles said, "because you won't give anyone a check for millions of dollars without seeing their face and looking them in the eye."

"But there's someone that has to do all of the legwork and get the meeting and make sure that those things happen, and even help report the fund's performance to databases so that those investors might call them."

Build Your Brand

A hedge fund could have all the pieces in place. But if investors don't know it exists, it won't go anywhere.

"If you don't have a website and you don't speak at events, how are you going to be known?" Ackles questioned. "I may be two blocks from you and have money to allocate to the type of strategy you have, but if I don't know you're there, and we don't meet each other, I'm never gonna write you the check. So you have to have some amount of publicity."

Ackles said that the other thing you need is a brand.

"It's not just your investment thesis and what you are and who you are, you need imagery to support it," he said. "If you have something interesting to say and comment on about what's going on in Greece or where the industry is heading or about regulation or even where the election is, if you have an opinion and it's legally okay to share it, you should, because you never know who's watching or reading, and that person might be qualified and reach out to you."

Clean Your Google Image

If you don't know what your Google results are, you could be in trouble.

"When people perform due diligence, the first step is Google," said Ackles. "So what do the search engines say about you? Managers have to worry about a lot of things they don't think about until it's too late. They have to worry about what their teenage daughter is posting to Facebook."

In his crisis work, Ackles aid that he has "cleaned up some Facebook pages for some multi-billion-dollar managers' daughters."

"[Hedge fund managers] have to worry about the perception of their family," Ackles insisted. "If you get large enough, you have to worry about security. There was a hedge fund manager that was kidnapped once -- at least one. So you have to worry about where you're going and who's protecting you. The larger you get, the more you're a target, just like any super-wealthy person might be."

Your Ethics, Your Hires

Hedge fund managers are also responsible for the ethical and moral conduct of their employees.

"A lot of the recent banking scandals, they weren't the senior people that were aware of them, or at least that's not what we've read or seen, they were people several [rows] down," said Ackles. "But [the senior employees] are the ones that have to take the hit and resign and all that. So you have to pick the right staff."

Ackles said that oftentimes a key aspect in all of this "is getting someone to screen and vet them."

"Getting a recruitment firm or going to a specific website that really digs through and determines, 'Is this person all they say and claim to be?' Because you are judged by your team," Ackles warned. "Just like in a bank, you want to make sure that the ship doesn't go down because someone lower in the management structure made an error in judgment or broke the law."

"These are all aspects you have to worry about in running a hedge fund," Ackles concluded. "Running a fund is not easy. A lot of managers spin off of other funds or other entities, and it's a shock to the system when they realize no one's putting coffee in the break room. They have to make sure that certain things happen that they may be used to other people handling."