How to start a hedge fund?

P2,

you are absolutely correct, if your goal is to become wealthy (through your trading abilities) then the way to go is to trade with other people's money and take a cut of the returns.

Unfortunately, the money comes with some strings attached (as it should!). Most traders who make the change are caught off guard. They suddenly see their job transformed from simply a trader to a manager, a salesperson, a psychologist, etc.

I'm not trying to turn anyone off from starting a hedge fund. My point is please go in with both eyes and ears wide open.
 
I have been a money manager for private investors. Not in the hedge fund structure, but in general its not much different. Just be prepared for all of the personal bullshit. Unless you are a very big fund with many layers of people, your investors are going to expect to talk to YOU, and whenever they want. In fact even if you have layers of people they still will want to talk to you. Thats OK, but be prepared because it is time consuming. Whoever said that you had to be a salesman, psychiatrist, etc, was very right.
 
I am presently involved in a small hedge fund and have a few observations:

The fee structure is usually as follows mgmt fee of 2% per year paid quarterly on assets under mgmt at the quarter start (addiions pro-rata by invest date). On a $2 mio fund that's $10k / quarter. Performance fees are 10-20% of high-water mark profits. Reach a NAV high and trade under it for the next three quarters, no performance fees (and likely lower mgmt fees as people pull assets away).

The big players in funding want to reward consistency - they want a low SD of returns, high Sharpe ratio, no surprises either way - so they structure the deal this way.

For example, let's take a proprietary mechanical trading system that has results (actual or hypothecated) showing an average monthly rate of return of 3% with an SD of +/-.4% over some reasonable time frame. They get their funding and start trading the program. If the fund returns aren't close to their expected results, the principals will be called in to explain why. If the results are significantly higher than prior testing, the funders will want proof that the risk parameters haven't increased. And if returns fall, well maybe they'll have another quarter to straighten it all out. This is h-o-t money, it moves in and out faster than one can imagine.

Triple digit returns are great - heck, high double digit returns make me giddy - but those returns almost certainly correspond to greater variance in returns.

And that's the deal breaker. It's also the pain in the backside factor; nobody bugs you when the variance is as expected and positive, but string together two bad months in a row and your phone won't stop ringing. Trust me, I have been there and it isn't fun...

If you could develop a program that returned a constant 3-4% per month with tiny variance over 5 years of trading real money, the institutional funders would throw all their money at you, hand over fist.

With regard to structure, offshore is the way to go; nearly none of the big guys are on-shore (open to US investors).

It may be better for a start-up to incorporate as an LLC and register in his/her state and the federales as an investment advisory firm. If assets and number of investors stay under some figure there's minimal paperwork.
 
Hmmmm. This all sounds like a lot of headache. A lot more than I considered at the start. What type of backoffice staff do you have. I assume I'm gonna need a secretary of some sort. I don't want to have to handle books of paperwork and non-stop calls all day. I assume that I'll also need at least one assistant (trader understudy). If I have a half dozen positions, I'm gonna need someone to put em on and monitor them. I can't sit there all day and buy 500 shares at a time in 10 different stocks at once.
You are also right about the low standard deviation of fluctuations. My current account fluctuates a lot. If you attatch a 50 day moving average to it, I doubt it has ever dipped under that, but I tend to have 2 good weeks, then baseline and lose a third of the gain before I have another hot streak. I guess big money people would be bothered by that.
Hypathetically speaking.... If I could return low tripple digits annually for a few years(100-150%), I see no reason why I couldn't charge more than the standard 10-20% range. I charge my dad 50% now, and he doesn' mind, cause I'm outpreforming every other fund out there. I assume that other investors would be similarly inclined.... (would you think this is true)
Finally, I don't know if I could do this all while attending school. Maybe I should wait til I graduate (flunk out) of college.....
 
College?! If you don't mind me asking, praetorian2, how old are you and what are you studying in college? And even more interesting, how do you find the time to attend college and trade full time simultaneously?

Rushman
 
P2,

If you have a trading account of $100,000, and you manage to mearly double that account each year, you'd have over $3,000,000 (before taxes) in just 5 years, and over $100,000,000 in 10 years.

I guess it depends on your definition of getting rich, but I would be very happy to keep things simple and trade my own money. Isn't that one of the best things about this business, that you don't have to put up with other people's bullshit.

Of course, as your account grows in size, it will become increasingly difficult to sustain a large rate of return each year.
 
I'm 20. I'm a trader, but my parents want me to remain in college, so I do. I'm a roman histroy major (as odd as that sounds). It's the only thing that in the slightest bit interests me in college. I put almost no effort into school besides just attending.
I would rather make much more honestly than just 3 mil 5 years out. Especially when you consider that I have to pay taxes and expenses out of that money. That's why the hedge fund option is definately the better approach.
 
P2,


What's your average time in a trade ?
The shorter your time frame ,the more difficult
to make the same % return with bigger money.
I'm also interested in starting a hedge fund.
I believe the best place to do so is offshore.
Less strict regulation,more flexibility...
I'm daytrading the E-mini S&P 500 and I did
some statistical research about how much
contracts can be traded with my specific style of
trading and guess what..
I have now put together a mathematical formula
that calculates the total dollar profit in function
of the number of contracts traded and the average
number of points made per trade.
So suppose you have a track record for trading 1
contract with enough trades(at least 30 and
better around 100) , I can calculate for which
number of contracts , I would maximize my dollar
profits. The graph is an inverse parabolic function
that reaches a maximum and goes back to zero
when a certain number of contracts are traded.
This is for daytrading the E-mini S&P.
So the percentage return you can achieve with
trading 1 contract, you cannot achieve when
trading more then 1. It's easy to understand.
Suppose you want to buy and there are only
5 contracts offered at the best offer and you want
to buy 20 contracts then you will get 5 at the best
offer and 15 at the next best offer, so your average
buy price will be higher then the best offer.
The best market in terms of liquidity is the Forex
market where you can move millions in seconds.
My point is that when you have a method of
trading , you should try to estimate how much
money can be traded that way with similar
performance....
 
I agree, I will loose some preformance with more capital. But I think I could very easilly do 100%+ still. My average trade of the type that I would do on hedge stuff would be probably a few hours-2 days. But I would also do position trading. I also know that in most things that I trade, I could trade 100k shares at almost the same prices as I currently trade 5-10k shares.
 
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