A hedge fund is a financial institution that trades and invests for individuals and companies. The funds deal with all types of assets like stocks, bonds, currencies and commodities. Some of the best-known hedge funds are Bridgewater Associates, Pershing Square Capital, and Greenlight Associates. These funds manage billions of dollars, making their owners billionaires. In this report, I will explain how you can easily start your hedge fund from home.
How hedge funds make money
In general, a hedge fund makes money in two ways. First, they charge their clients an annual management fee. This tends to be about 1% or 2% of the amount invested and is intended to pay for activities relating to managing the firm. Some firms charge more than 2% depending on their performance. Second, hedge funds make money by charging an incentive fee, which is usually 20% of all the profits the fund generates.
Here’s an example of how a hedge fund makes money. Assume that you have a fund with $10 million in assets under management and you generate a 10% return in a year. In this case, your management fee revenue will be $200,000 while the incentive fee will be $200,000, bringing the total to $400,000.
Hedge funds tend to have low operational costs. First, you don’t need to pay an expensive office space. Indeed, some relatively small hedge fund managers operate in their spare rooms. Second, you will need a fast internet, high-quality computers, and excellent data platforms. Some of the most common platforms are the Bloomberg Terminal, Reuters Eikon, and Money.net. Finally, to stay within the law, you need to file taxes.
Start with a strategy
In most cases, hedge funds are started by people who have worked for several years in either an investment bank, hedge fund, or a private equity firm. Indeed, this is the best strategy for you to follow if your goal is to start a fund. It will give you exposure and experience about the strategies used by bigger hedge funds. It will also help you increase your network, especially when you start the fundraising process.
However, some of the most successful hedge fund managers did not start working in one of these institutions. For example, Bill Ackman, the founder of Pershing Square Capital started his first fund after graduating from campus.
The most important part of starting a hedge fund is having a proven strategy. As such, before you raise money from external investors, you will need to have spent a few years investing your money and testing the strategy.
Types of hedge fund investing strategies
Hedge funds use several key strategies. Some use a single approach while others combine several investing strategies.
Some of these are:
- Long only funds – These are funds that only buy stocks and other assets and expect their prices to rise.
- Short only funds – These are hedge funds that focus on identifying overvalued assets and shorting them.
- Quantitative funds – There are funds that specialise on using complex algorithms to find investing opportunities.
- Activist investing – These are hedge funds that find under-priced companies, invest in them, and then advocate for changes. Only funds with a substantial amount of money can use this strategy.
- Trend following funds – These funds focus on identifying an already-established trend and invest or short them.
- Long-short funds – These funds buy assets they hope will go up in value and short those they see dropping in value.
- Special events – These are funds that make money whenever special events happen. For example, merger arbitrage funds focus on when there are mergers and acquisition.
A hedge fund can also be classified by the types of assets that they invest in. For example, there are hedge funds that focus on currencies, stocks, exchange-traded funds, and commodities, among others.
In all, before you approach people to invest in your fund, we recommend that you spend a few years defining and testing your strategy. Have the figures with you.
Raise money
The next step for starting a home hedge fund is to raise funds from investors. To most people, this is usually the toughest part. However, a good approach is to start raising the funds from your family, friends, and colleagues. To do this, you need to just talk to them about your fund, and show them your performance.
If you are starting a huge fund that will attract funding from large institutional investors, the best approach is to use an investment bank. In the US, examples of these funds are Goldman Sachs, Morgan Stanley, and JP Morgan. These banks have the network and experience in helping people raise money.
When raising funds, ensure that you:
- Have registered your fund for tax purposes. In the US, you need to be a qualified investment advisor to invest other people’s money.
- Talk about your investment strategy – Explain to your investors how you will invest the money.
- Have them sign your terms and conditions – Because of the risks involved, it is recommended that you have a lawyer to define your terms and conditions.
- Start small – Don’t raise too much money initially. Instead, start small and grow your fund as you go.
Start investing
Finally, now that you have an investing strategy and funds, it’s time to start your fund. Depending on the size, you can manage the funds yourself or you can hire a team to help you out. Indeed, most small hedge funds are run by a team of less than 5 managers. An ideal team should have a portfolio manager, research assistants (portfolio managers), and an investor relations professional.
A few strategies will help you in this:
- Start with a team of people you know well.
- Always follow your tried and tested investing strategy.
- As the senior portfolio manager, the buck stops with you.
- Always send a letter to your investors regularly. Most hedge funds send a detailed letter on decisions once per quarter.
- Always be accurate about your performance.
Final thoughts
A hedge fund is one of the best businesses that you can start. For one, you just need to have investing experience and a track record of making money. Also, the cost to run a fund is relatively low and the potential income is unlimited. However, hedge funds can also be traumatising. In fact, most of the funds that are started usually end up failing. This is part of the reason why you need to have good terms and conditions to protect yourself.
