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Where do you begin in launching your own Hedge Fund?

2009-04-13T16:26:00Z

Where do you begin?

Begin by deciding on your trading strategy and assessing your accredited investor client pool.

Generally, US Hedge Funds are set up as Limited Partnerships. To accommodate this structure, we set up a Limited Liability Company which functions in the role of General Partner to the Limited Partnership. The General Partner (the LLC) appoints the Investment Manager. The Investment Manager may be a registered Investment Adviser, if you have more than 15 investors, you must have a registered Investment Adviser. The Investment Manager makes all trading and investment decisions for the Fund.

As I mentioned above, we must also set up a Limited Partnership, this is in effect the investment fund partnership. The partners of the fund share in the profits of the fund according to their partnership agreement.

You will need to provide a name for the LLC and a separate name for the LP.

You will need to designate where your office will be located, which custodian you plan to use to clear your trades, which bank your plan to use, who your accountant will be, and if you plan to have a fund administrator.

You will also need a detailed Offering Memorandum, this is the document you give to your clients, it details your trading strategy, what type of risks you plan to take, and what sector you plan to invest in. Attached to the Offering Memorandum is the Subscription Agreement, this is a series of questions about the financial status of your clients to determine if they are accredited investors. As due diligence on your part, you must have each of your clients complete the Subscription Agreement.

How much do you need? There is no minimum to start a Hedge Fund, however to gain access to Capital Introduction you generally need a minimum of one million dollars.

How do you create your own fund? Contact scottgoldringassociates.com />

What is an Accredited Investor?

2009-04-08T19:42:00Z

The federal securities laws define the term accredited investor in Rule 501 of Regulation D as:

a bank, insurance company, registered investment company, business development company, or small business investment company;
an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
a charitable organization, corporation, or partnership with assets exceeding $5 million;
a director, executive officer, or general partner of the company selling the securities;
a business in which all the equity owners are accredited investors;
a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase;
a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

http://www.sec.gov/answers/accred.htm

How do you start a Hedge Fund?

2009-03-29T19:49:00Z

So, what is a Hedge Fund, and how do I start one?

A hedge fund is an investment fund usually limited to accredited investors. The difference between a Hedge Fund and a traditional Broker - client relationship, is that the money that is invested in the fund is pooled together which allows the manager to take on larger and perhaps riskier positions. Hedge Funds seek to balance their portfolio by utilizing different trading strategies; such has long or short positions, option trading and utilizing margin.

There are a number of different structures for Hedge Funds: the traditional domestic fund, feeder fund, master feeder fund and parallel structure.

A United States Domestic Hedge Fund is normally set up as a Partnership. The investors are Limited Partners and the Fund Manager is the General Partner. To facilitate this structure you need to form two entities. Generally the Fund Manager will form a Limited Liability Company as the Management Company. The LLC will serve as the General Partner and will appoint the Fund Manager. The LLC will also receive the Management Fee. The management fee is intended to compensate the Fund Manager for their time and expertise and can be structured in a number of ways. You may hear people refer to "2 and 20", this refers to a 2% management fee, which can be paid monthly, quarterly or yearly, and a 20% end of year percentage of profits. The 2% management fee is used to pay the expenses of operating the fund; the 20% is an incentive bonus.

The Limited Liability Company which operates as the General Manager generally details the powers and structure of the General Manager. The General Manager should have the exclusive right to make all investment decisions on behalf of the Partnership.

The Limited Partnership is made up of the investors and generally details the rights and obligations of the partners. It details what the minimum investment is, how long that investment will be locked up, the ever important indemnity clause, and how and when the investor may make a withdrawal.

The Offering Memorandum, details the trading strategy, the rights and obligations of both the investor and fund manager, and includes the subscription agreement which asks questions about the investor's financial stability. You may have unaccredited investors in Hedge Funds, but I don't recommend it because I believe it could increase your liability and dilute the protection you created with your indemnity clause.

How do you start a Hedge Fund .... by contacting Scott Goldring Associates at 646-652-8567.

The power of a well written indemnification clause

2009-03-23T15:48:00Z

A well structured indemnification clause can save you a mountain of grief later. There are many scenarios in which a well written indemnification clause can help you, that angry client who can't understand how you lost their money, even though it was the worst market since the great depression, you simply chose the wrong strategy and shorted at absolutely the wrong time, or the sector of the market in which you trade has taken a beating, and while you know these stocks are currently undervalued and a good buy in the long run, in the short term it looks like a loss.

The indemnification clause generally includes a provision which states that the General Partner, its affiliates, associates agents and employees, shall not be liable for a loss suffered by the Partnership unless said loss is caused by its "gross negligence or willful misconduct". This is the norm, but for added protection, the term gross negligence or willful misconduct should be limited by including language that describes common acts that would not amount to gross negligence or willful misconduct. For example, making a decision to invest in stocks within a specific sector of the market, even though that sector of the market has had a dramatic drop in value, does not rise to the level of gross negligence or willful misconduct. Holding a stock as it falls is not gross negligence or willful misconduct, a stupid trading decision or a trading decision that result in a loss, does not rise to the level of gross negligence or willful misconduct. Give yourself the added protection by describing common acts that may occur in a trading environment.

Your General Partnership Agreement, Limited Partnership Agreement and Offering Memorandum should all have separate detailed indemnification clauses. The wording can be similar, but each should be specific to the agreement which it represents. You should also add permissive language, which allows you to do certain acts or to rely on third parties. For example, the General Partner may consult with counsel and accountants in respect of the Partnership's affairs and, in acting in accordance with the advice or opinion of such counsel or accountants, the General Partner shall not be liable for any loss suffered by the Partnership, provided that such counsel or accounts shall have been selected with reasonable care.

As the General Partner, you will be making the decisions for the partnership, be those decisions, trading, investing in real estate, or venture capital, you need the freedom to take chances without fear of retribution if the stock should go down, the value of the real estate drops below the level at which you purchased it, or the business plan was flawed. You must be specific in including wording that allows to make these decisions, and wording that protects you once these decisions are made.

How to make the move from Broker to Hedge Fund Manager

2009-03-21T00:26:00Z

It is not necessarily as hard as you may imagine to make the move from Broker to Hedge Fund Manager. You may think you need 25 million to get started, but you can start with 1 million or even less. If you are looking to break away, there are a number of ways to transition your clients into first a independant Broker-Client relationship, and then into a Hedge Fund structure.
It may all appear daunting at first, setting up an LLC, and LP, coming up with a clear concise trading objective, and finding accountants, but with the right guidance even a small fund can flourish.

When considering any transition, most retail brokers will ask the following question: How can I make a viable living? If you are a broker who has the ability to make your own investment and trading decisions it may interest you to know that you have many choices.

Some Brokers may be used to paying 60-70% of thier hard earned commissions to a Brokerage House, but most are not aware that there are ways your only slippage cost could be less than $0.005 per share. There are clearing firms that will facilitate a Broker Dealer arrangement with your clients.  These clearing firms on many occasion offer far more tools than the typical retail broker is accustomed to.

The clearing firms who offer this service will hold on record the client/broker agreement as well as the power of attorney, which allows the transfer of monies to the broker’s master account as per the client/broker agreement. These agreements can be structured on a monthly, quarterly or yearly basis. The clearing firm will furnish all monthly and tax statements, the broker will execute all trades, and the client will gain access to his account on a daily closing basis. When clearing costs are much lower, the broker can negotiate a client/broker agreement that benefits the client and broker and not the brokerage firm.

In today’s rapidly changing environment the personal trust between broker and client and the relationship that has been built over a number of years must be preserved and is perhaps the only constant.   The typical retail broker environment encourages a large up front commission and as a consequence a more buy and hold oriented approach. It is quite clear that in order to successfully compete in today’s environment one must have, amongst other things, the ability to long/short stocks and utilize option markets to manage risk.

A broker may not wish to rely on research that told him to buy a stock at $60 over ten years ago when it is at $40 today. Instead the broker must take control of his destiny and utilize tools that are may not be available to the typical retail broker. The speed and cost of execution, trading costs as low as $0.001 per share, real time Theta and Delta analysis, 6 for 1 margin on qualified accounts, real time balances; access to a plethora of fixed income opportunities; theses are all tools that are quintessential for managing money in today’s world, and grant the retail broker a departure from the buy and hold strategy that is so often his only option.

If a broker wants to pool his resources and start a hedge fund then the process can be facilitated within a month. The fees associated with the formation of a fund are generally amortized over a five year period, these start up costs are generally reimbursed to the General Partner by the Limited Partnership.  There is no minimum amount needed to start up a fund, you can begin with $100,000.00 or 1,000,000.00.   When starting a new fund it is important to facilitate transparency with a reputable accounting firm, one that makes itself accessible.

The standard compensation for a Hedge Fund Manager is 2/20, but it is at the discretion of the General Partner and can be negotiated with each client. It is not uncommon for the General Partner to receive a monthly management fee, but the profit incentive is usually paid at the end of the year again the structure can be negotiated and customized.   As a Manager of a Hedge Fund a Broker may set up a standard 2/20 agreement with his client, and pay a total round trip commission cost of $0.006 per share or less. If, for example, a broker can generate a 30% return on $5 million, his compensation could be $380,000. If a broker generates no return then his income could be $100,000.   How much business would a broker need to generate to receive that type of income in a regular commission environment?

The primary advantage of utilizing a fund structure is the ease at which beta and performance can be advertised in order to bring in additional capital.   As everyone is looking for low   beta high returns, these are important characteristics that institutions and private investors quantify when appropriating new capital.

As the retail brokerage industry moves through its own transition, retail brokers may appreciate that they must transition as well. The importance of receiving the right advice and guidance when you make that first step cannot be underestimated.

Welcome

2009-03-19T19:22:00Z

Welcome to the Scott Goldring Associates Blog. This Blog deals with issues and ideals surrounding the formation of Hedge Funds.

If you would like information on forming a Hedge Fund, visit www.scottgoldringassociates.com for more information.

For other economic and financial commentary visit www.goldringstockpicks.com