Setting up a prop-trading firm vs. a hedge fund

[PBS]

2/20 is not viable for small amounts as you found. Basic math.


Depending on how consistent your profits are, it may make sense to raise debt instead of equity capital.

I am coming to a conclusion that fixed income debt (corporate bonds) would be the easiest way to raise capital. Investors, especially in the country where I would carry out the initial raising activity, like to know what they are guaranteed to get.
That would be a huge risk for me and my company but probably this is the most realistic option

 

[cruisecontrol]

I am coming to a conclusion that fixed income debt (corporate bonds) would be the easiest way to raise capital. Investors, especially in the country where I would carry out the initial raising activity, like to know what they are guaranteed to get.
That would be a huge risk for me and my company but probably this is the most realistic option

My advice is don't take huge risks. Debt is leverage. Know your strategy and determine the appropriate leverage conservatively.

A good rule of thumb is, estimate your worse case drawdown and then double it. If that makes you uncomfortable then you're using too much leverage.

e.g. if the worst drawdown for your strategy (unlevered) is 5% and you are uncomfortable with a drawdown of 20%, your max leverage is 20%/(5%*2) = 2x.

 

[ZZ Trader]

PBS:

I disagree with the whole theory: "investors won't find you, no matter how good you are".

When you say "this or that manager has been in business for 10 years, great track record and still stuck at 1M AUM", it means that manager is NOT THAT GOOD!

You see, investors do not judge a manager just by x% returns a year, there is a complex equation and a lot of parameters to evaluate in a manager you want to invest in (I work in the industry, I am a portfolio manager), but if you do have a "product" that can fit in somebody's portfolio, then you can find the investors, it's not going to be easy, but nothing is easy in this business. You don't make a lot of money with something easy.

That's point 1) to reflect on.

Point 2) is the following: what is your % return a year? Can you make consistently =>50% a year and scale? (scale means that you will be able to scale either your strategy or add more strategies in your portfolio as the AUM grows and after that you will keep returning =>50% a year, every single year).

If you can do that, you will be a billionaire in 20 years, simple math. Why bother with clients or prop business of any kind?

Point 3) the idea of listing a prop trading company to get funded is complete nonsense, if it was a great idea everybody would be doing it. Do not assume everybody is a moron and you just discovered a genius way to do business, if everybody else in the industry is not doing what you proposed, try to find out why nobody else is doing it, that would be a good heuristic to find out why it is a bad idea and some posters already gave you some hints in this thread.

 

[HlibKozakXX]

ZZ trader, thank you!
From your experience, what ratios are the most important for institutional investors today?

 

[betcashrun]

I am considering setting up a prop-trading company with $200k of my own capital to raise assets of around $1-2m from investors, giving me around 40% of shares and profits of the company.

In details it means for instance:
1/ to found the company with $200k (20m shares at $0.01)
2/ to find investors with $1.8m through a share capital increase (30m shares at $0.06)
As the initial founder you still own 40% of the company.
Your net worth jumps from $200k to $1.2m.
$0.06 is still cheap.
Your power of selling paper is good!

 

[PBS]

What legal structure do you suggest then? Set up a company and use instruments like shares/bonds to raise capital?
Or set up a fund and bear higher operating costs and then look for investors in the fund?

I was thinking about an ETF but there would be an issue with daily redemptions/purchases which would make proper position sizing in active trading impossible. Simplified example: assets = $50m; your trade loses $1m and investors redeem $10m which you find out about the next day. This redemption makes the % change much worse. Unless I am getting it wrong

 

[cruisecontrol]

PBS:

I disagree with the whole theory: "investors won't find you, no matter how good you are".

When you say "this or that manager has been in business for 10 years, great track record and still stuck at 1M AUM", it means that manager is NOT THAT GOOD!

You see, investors do not judge a manager just by x% returns a year, there is a complex equation and a lot of parameters to evaluate in a manager you want to invest in (I work in the industry, I am a portfolio manager), but if you do have a "product" that can fit in somebody's portfolio, then you can find the investors, it's not going to be easy, but nothing is easy in this business. You don't make a lot of money with something easy.

That's point 1) to reflect on.

Point 2) is the following: what is your % return a year? Can you make consistently =>50% a year and scale? (scale means that you will be able to scale either your strategy or add more strategies in your portfolio as the AUM grows and after that you will keep returning =>50% a year, every single year).

If you can do that, you will be a billionaire in 20 years, simple math. Why bother with clients or prop business of any kind?

Op is an independent trader, not a fund manager. These are two different career paths that have little in common and it's rare to switch between them. Track record in one does not translate to the other (usually). This is because the strategies employed are completely different in scale and frequency. Traders can operate starting with $100K AUM, fund manager is starting with $10MM. It's a 100x difference! If you managed to compound all the way from $100K to $10MM as a trader, you probably rather retire than get into fund management and take an epic pay cut. Yes there are some traders who have managed to scale up to billions but they are rare exceptions, not the rule.

You asked "why bother with prop business" ? Well, prop firms are vehicles for leverage and tax. Just because someone can make 50%/year, doesn't mean they wouldn't be better off making 100% or 200%/year with a prop structure.

 

[cruisecontrol]

What legal structure do you suggest then? Set up a company and use instruments like shares/bonds to raise capital?
Or set up a fund and bear higher operating costs and then look for investors in the fund?

I was thinking about an ETF but there would be an issue with daily redemptions/purchases which would make proper position sizing in active trading impossible. Simplified example: assets = $50m; your trade loses $1m and investors redeem $10m which you find out about the next day. This redemption makes the % change much worse. Unless I am getting it wrong

You know companies can just take loans right? Find some rich people and have them write a loan to the company.

Anything publically tradable (shares, bonds, etf) makes basically no sense... these are secondary markets. You can't just raise capital by clicking a button to sell on the public market. You think you're going to market make your own ETF or something? IMO There's no way you would ever get approved / meet requirements for these kind of things.

 

[betcashrun]

What legal structure do you suggest then? Set up a company and use instruments like shares/bonds to raise capital?
Or set up a fund and bear higher operating costs and then look for investors in the fund?

It is ok to raise capital at a higher share price (as long as one can convince investors). For a small corporation, two main instruments are used: capital (voting rights) or partnership account (no voting rights but rate of interest, if any, to be paid).
The legal structure depends from the incorporation country and your legal and tax considerations.

 

[trismes]

You know companies can just take loans right? Find some rich people and have them write a loan to the company.

Cruise, would this not be circumventing the rules on required regs to attract investment? Unless you tied the loan to an absolute rate of return it would be classified as investing wouldn't it? I'm UK based so may well be different but interested if you know