Starting a fund / raising capital

[1245]

You made a few statements and I don't find them accurate. I've been in the business since 1981 and have only traded for myself, but everyone around me, in general, traded for prop firms that had many traders that were backed by the firm.

You said,"From my understanding really good traders make at least 20% per year on the lower end".When you start trading with AUM of $1M or more, this is just not true in both up/down/sideways markets consistently, without risk. With risk comes varied returns. No edge last for ever. Some investors or allocations don't want risk. I spoke to one guy in 2009 that runs $6B for an offshore pension fund and their target for him was 6% with as much capital protection a possible. Why, because 6% after fees makes the board of the pension meet their mandate and their expected spending.

Then you said, "Real Traders" trade for themselves, fake traders need other people money to loose".
Given that I have only traded for myself, I still find this not to be true. I learned a long time ago, that trading is a business. And, like other businesses, I find this statement to be true. "If you have a talent that has value, use other to fund your business". If you are a chef, find investors to fund your restaurant. If you are starting the next social media firm, find investors. And, if you are a trader, find investors to fund your trading. Those that have talent but don't make use of investors, either never had access to investors or never looked. In my case, I never looked, but I wish I did.

The fact is that not every business works the first time, or every time. By adding your talent to trade with their money, you give yourself better odds to succeed. You also get the benefits of scale. It takes the same work to trade $100M as $1M. You need an infrastructure in place with investors that you don't need without them.

If I was getting into the business right now, I would focus on a track record to interest investors. Then move forward and build my trading business around that.

 

[Blackdollars]

You made a few statements and I don't find them accurate. I've been in the business since 1981 and have only traded for myself, but everyone around me, in general, traded for prop firms that had many traders that were backed by the firm.

You said,"From my understanding really good traders make at least 20% per year on the lower end".When you start trading with AUM of $1M or more, this is just not true in both up/down/sideways markets consistently, without risk. With risk comes varied returns. No edge last for ever. Some investors or allocations don't want risk. I spoke to one guy in 2009 that runs $6B for an offshore pension fund and their target for him was 6% with as much capital protection a possible. Why, because 6% after fees makes the board of the pension meet their mandate and their expected spending.

Then you said, "Real Traders" trade for themselves, fake traders need other people money to loose".
Given that I have only traded for myself, I still find this not to be true. I learned a long time ago, that trading is a business. And, like other businesses, I find this statement to be true. "If you have a talent that has value, use other to fund your business". If you are a chef, find investors to fund your restaurant. If you are starting the next social media firm, find investors. And, if you are a trader, find investors to fund your trading. Those that have talent but don't make use of investors, either never had access to investors or never looked. In my case, I never looked, but I wish I did.

The fact is that not every business works the first time, or every time. By adding your talent to trade with their money, you give yourself better odds to succeed. You also get the benefits of scale. It takes the same work to trade $100M as $1M. You need an infrastructure in place with investors that you don't need without them.

If I was getting into the business right now, I would focus on a track record to interest investors. Then move forward and build my trading business around that.

Coming from someone who trades his own money this is a good perspective. I do agree that those words may be insulting to some, especially if they trade for others.

In America, using other people's money to enter business is the norm. Good point.

 

[Blackdollars]

I'm not sure if my associate consider trading for a prop firm as trading for the public, but I don't. The one prop firm I know of, you have to stake your personal money with theirs.

 

[Epic]

From my understanding really good traders make at least 20% per year on the lower end. This select group usually do not trade for others although they do teach how to trade (read "Millionaire Traders"---interviews with "real traders").
From reading this thread, if you live in the US it doesn't seem to be worth it to trade for others, unless you have low returns, so you do need alot of money under management to make decent money in fees and commission.

Firstly, really good traders don't make "20% per year on the low end". The best make 20% on the high end over anything more than a 10 year span. There are only a relative handful who do better than that. the majority who produce those kind of returns either end up managing OPM or blowing up their account multiple times.

Above is a very distorted view of the benefits of trading OPM. It really has to do with what your objectives are. BOTH trading for yourself for a living and trading OPM for a living require the same skill to profit consistently. Managing OPM is much harder in the end. OPM managers do not typically have lower gross performance long term than individuals. There are a couple things that might make it seem this way.

1) Managers report returns net of fees. A manager 'only' getting 12% annual is actually getting closer to 20%+ before fees and other costs. Also, if the manager uses introducing brokers or primes for fundraising, they will typically insist that the trades are cleared through them. This means much higher commissions or give-up fees. The manager no longer gets to pick a low cost leader like Interactive Brokers. So assume 2/20 fee structure and 20% gross return. The management/incentive fees reduce the reported performance to 14%. Research and experience indicates that most intro brokers result in a 1-2% lower net performance because of higher commissions. Spread the data fees, audits, admin, etc across all the partners and the performance is down another 1-2% depending on fund size. So when that manager reports performance, it will show 10-12%, while his personal account trading the same system will be very close to 20%.

2) Managers are subjected to MUCH more limiting risk controls. In a prop account, when a good trade comes along, you are free to load up the boat. If that trade screws up and costs you 15% of your account, you just move on to the next one. An OPM manager would lose most of his investors. Of the handful of prop guys hitting 20% annual, most have a MAR (ROMAD) of close to 1.0. Many are even lower. This means max drawdowns as big or larger than the annual return. That isn't good enough for most allocators, who want to see it closer to 2.0 on a net basis. So the prop trader who doesn't mind letting his account drop 20% as long as he is getting >20% annual returns would never survive as a manager. In the example above of 12% reported annual returns, many investors will expect a max drawdown no greater than 6-7%. For the manager to achieve that, he is really getting 20% annual returns with a 7% max drawdown. There are very few individuals who accomplish this over more than a 5 year span. Prop traders have a nasty tendency not to recognize the risk. Managers are forced to.​

What do you all think of the following statement
"Real Traders" trade for themselves, fake traders need other people money to loose.

What my associate is saying (in private conversations) a good trader need, $10,000 in order to get rich, people who don't know how to trade "needs" other people's money.

How accurate or inaccurate is this statement in your opinion?

I can tell you right now that I've met several of the 'real traders' you refer to. Almost all of them portray an image that is far removed from reality. They claim to make >20% annual, but forget about the three times they blew up their account. They "make so much $ they would never want the hassle of trading OPM", but they are in and out of their mom's basement because they can't maintain a steady income stream.

I can tell you the actual reality. A 'real trader' is someone who practices proper money management techniques to ensure that he doesn't risk blowing up. (Most research indicates about 20-25% max allowable drawdown for a long term sustainable system.) He has an edge and treats trading like a business. Of this group, there is a relatively small group of skilled traders able to achieve >20% annual long term (20+ years).

If he started with $10K and this is his only source of income, he is living in his mom's basement off food stamps, and his account never consistently grows because he spends every dime he earns just trying to live. This 'real trader' will never "get rich".

Then there is the 'real trader' who holds down a good day job for a steady paycheck while trading. This allows him to compound the returns, and "rich" is now at least a possibility. But, even this guy is gonna need a lot of time to get there. If he works during the day, it's hard to devote the necessary time to maintaining the trading edge, but we'll assume he's dedicated and able, or works at night. He gets 20% annual and pays around 25% tax on those gains. That's 15% net return. If he started with $10K and compounded every dime of the profit, it would take him 33 years to reach $1MM, which by then would be worth about $250K after inflation. You would hardly consider him rich and, in fact, his passive 401K gave him a better shot at wealth than the trading did.

Instead, let's put him in an IRA so he won't be paying tax on the gains. Still takes him 25 years to reach $1MM. Hmmmm.... let's assume that he really does want to "get rich" trading within a reasonable time period like 15 years. We'll set the $1MM level as the target and assume 3% annual inflation eating away his wealth. So in 15 years he'll need about $1.6MM. That means he'll need at least 40% net gains EVERY YEAR for 15 years, in a tax free account, never making a withdrawal. He needs to do this without risking more than a 20-25% drawdown. In the end it still took him 15 years of working a day job and trading at a level of skill that only a handful in the world may have ever done, and he is barely rich.

Or after 3 years of consistent performance he can put himself out there and start getting indications of interest from investors. It'll be slow at first, and at the 5 year mark he probably only has about $5MM AUM. But if the performance continues, another 2 years and he'll probably reach about $20MM, and he's making more than $1MM annual in fees. All the while, he was still able to trade his own prop account.

What were you saying about 'real traders' again?

 

[Blackdollars]

[quote="Epic, post: 4018740, member: 260646"

I can tell you right now that I've met several of the 'real traders' you refer to. Almost all of them portray an image that is far removed from reality. They claim to make >20% annual, but forget about the three times they blew up their account. They "make so much $ they would never want the hassle of trading OPM", but they are in and out of their mom's basement because they can't maintain a steady income stream.​

What were you saying about 'real traders' again?[/quote]


Haaa, LOL. Yeah this sounds like me, only I'm married with kids and never lived in my Mom's basement.

Anyway you are right about blowing up accounts, I would not be considered one of those "real traders" but last year I made 79%, and this year, I'm really struggling for air. However my associate claims to be consistently over 100% per year, but from what I know about him, he does not fit in your story above, either. He's not extra frugal but not flashy or boastful either.

 

[Epic]

Haaa, LOL. Yeah this sounds like me, only I'm married with kids and never lived in my Mom's basement.

Anyway you are right about blowing up accounts, I would not be considered one of those "real traders" but last year I made 79%, and this year, I'm really struggling for air. However my associate claims to be consistently over 100% per year, but from what I know about him, he does not fit in your story above, either. He's not extra frugal but not flashy or boastful either.

I can't say one way or the other regarding your associate, but my rule is that anyone making fantastic claims should be absolutely willing to provide proof. There is not a single documented and verified case that I'm aware of where someone has achieved 100% annualized returns for anything close to 10 years without exceeding 50% drawdown risk. I've crossed paths with many traders claiming more than 100% annual consistently. Without exception, they fell into two categories. 1) Only been doing 100% returns for 1-3 years. 2) Maintained a drawdown risk of above 50%, and usually closer to 80%.

Sometimes it was a combination of those two things. They'd been doing it for a couple years, and just hadn't put the effort into realizing that they were risking 80% until the blowup happens a year or two later. In the world of traders, statistically there will always be a group that achieves fantastic performance for some short period, especially if he is taking on very high risk to get there. I was recently privy to a conversation in which one person was claiming to have achieved 100% annualized over 15 years. As it turned out, he was being truthful on that point, and provided the documents to back it up. But upon closer inspection, when the returns were dissected into a weekly equity curve, there were 4 peak-to-trough drawdowns of more than 75% during that 15 years. And two of those cases were greater than 90%.

He had originally started with something like $40K and he just withdraws any profits at the end of each year. He was asked why he didn't scale it up and compound the returns. He'd have like $120MM 15 years in, even after taxes. Then the truth came out. He kept other capital available for if/when he got margin called. Every 7-10 years there would be a drawdown large enough and early enough in the year to take the $40K down to below $10K in the course of less than a month. He'd simply replenish the account from old profits held elsewhere. It was pointed out to him that holding money in a different bank account to "re-buy" after a blowup every several years isn't really achieving 100% gains. It is called "committed" or "notional" capital and should be counted as part of the account value even if held elsewhere. In the end, it turns out he was actually only getting 50% annualized returns, with a 45% drawdown risk when the performance was properly calculated. Even then, it couldn't be compounded easily. If he were to fund the account to a level where it could be realistically compounded, he would've only been getting 25% annualized (pre-tax).

These types of situations are very common with prop traders. They are unfamiliar with the procedures for calculating true returns or getting any type of accurate risk estimation. They go around thinking they are the best trader in world, and talking about how easy it is until they blowup. Even after blowing up, many of them continue to claim extraordinary success.

 

[Blackdollars]

I can't say one way or the other regarding your associate, but my rule is that anyone making fantastic claims should be absolutely willing to provide proof. There is not a single documented and verified case that I'm aware of where someone has achieved 100% annualized returns for anything close to 10 years without exceeding 50% drawdown risk. I've crossed paths with many traders claiming more than 100% annual consistently. Without exception, they fell into two categories. 1) Only been doing 100% returns for 1-3 years. 2) Maintained a drawdown risk of above 50%, and usually closer to 80%.

Sometimes it was a combination of those two things. They'd been doing it for a couple years, and just hadn't put the effort into realizing that they were risking 80% until the blowup happens a year or two later. In the world of traders, statistically there will always be a group that achieves fantastic performance for some short period, especially if he is taking on very high risk to get there. I was recently privy to a conversation in which one person was claiming to have achieved 100% annualized over 15 years. As it turned out, he was being truthful on that point, and provided the documents to back it up. But upon closer inspection, when the returns were dissected into a weekly equity curve, there were 4 peak-to-trough drawdowns of more than 75% during that 15 years. And two of those cases were greater than 90%.

He had originally started with something like $40K and he just withdraws any profits at the end of each year. He was asked why he didn't scale it up and compound the returns. He'd have like $120MM 15 years in, even after taxes. Then the truth came out. He kept other capital available for if/when he got margin called. Every 7-10 years there would be a drawdown large enough and early enough in the year to take the $40K down to below $10K in the course of less than a month. He'd simply replenish the account from old profits held elsewhere. It was pointed out to him that holding money in a different bank account to "re-buy" after a blowup every several years isn't really achieving 100% gains. It is called "committed" or "notional" capital and should be counted as part of the account value even if held elsewhere. In the end, it turns out he was actually only getting 50% annualized returns, with a 45% drawdown risk when the performance was properly calculated. Even then, it couldn't be compounded easily. If he were to fund the account to a level where it could be realistically compounded, he would've only been getting 25% annualized (pre-tax).

These types of situations are very common with prop traders. They are unfamiliar with the procedures for calculating true returns or getting any type of accurate risk estimation. They go around thinking they are the best trader in world, and talking about how easy it is until they blowup. Even after blowing up, many of them continue to claim extraordinary success.

Well then, this is the reason these type of traders do not trade for others. In my back test my drawdown was similar as you described above. But in my case, I'm willing to take that hit. In a course of a year, I had 4 months of what I call "disaster trading" in all my back tests. I don't want to say what the end results were, but lets just say its worth the drawdown. My associate Bruce is coaching me, even though my system is a little different from his. One advise, is to remove 50% profits monthly and diversify. The idea is due to large draw downs, and periods of no income (he advise me not to charge myself a 2% management fee, lol) I will later appreciate multiple income streams.

I cannot prove Bruce earns over 100% annually but i've known him since college. He now owns franchises, a club and various real estate which all came from trading. When we were closer friends (last year of college) he even tried to teach me then, but I rejected his offer. So to be honest I really don't feel like asking him for proof, just taking his advise since I know of his history and spoke to him on and off for a couple decades now.

But for what its worth I definitely understand where you're comming from.

 

[Epic]

Well then, this is the reason these type of traders do not trade for others. In my back test my drawdown was similar as you described above. But in my case, I'm willing to take that hit. In a course of a year, I had 4 months of what I call "disaster trading" in all my back tests. I don't want to say what the end results were, but lets just say its worth the drawdown. My associate Bruce is coaching me, even though my system is a little different from his. One advise, is to remove 50% profits monthly and diversify. The idea is due to large draw downs, and periods of no income (he advise me not to charge myself a 2% management fee, lol) I will later appreciate multiple income streams.

I cannot prove Bruce earns over 100% annually but i've known him since college. He now owns franchises, a club and various real estate which all came from trading. When we were closer friends (last year of college) he even tried to teach me then, but I rejected his offer. So to be honest I really don't feel like asking him for proof, just taking his advise since I know of his history and spoke to him on and off for a couple decades now.

But for what its worth I definitely understand where you're comming from.

Yeah, in the OPM management world, you'd never hold onto clients with high volatility. Even with 100% target returns, if you ever had a 50% drawdown, you'd lose almost every client. 20% will start looking elsewhere at 15% DD. The more aggressive ones will actually increase their allocation at that point. Sort of like averaging down on a value stock. At 30% DD, you'll lose most of them though. 50% are probably gone at that point and another 30% are needing something convincing to stay. The really aggressive ones will stick around, but unfortunately, they typically aren't heavily allocated to you.

A lot of if has to do with high water mark. If annualized returns are 100%, it means that there are plenty of years where you'll be at 50-90% returns, and a few that are closer to 200%. If you suffer a 50% drawdown, you'll need 100% returns to exceed the high water mark. That's going to take more than a year on average. A year of no income. Managers start getting desperate for income and taking on more risk to get back to profitability. Risk goes up and returns typically go down under this circumstance.

It's strange, but in the OPM world, a huge majority just want 15-20% annual, with less than 5% vol and <10% max DD. Do that, and you'll almost never lose a client. With that performance and some hard work, you can raise $50MM pretty easily with a 2/20 fee structure. That's around $2.5MM annual revenue. Make sure it is a low leverage program and allow your clients to lever it on their end if they want, typically 2-3X. If they want to chase the 40-60% gains, they are doing it of their own volition, but it doesn't affect your management at all.

 

[Butterfly]

Like many a young analyst or trader, it has long been a dream of mine to run a successful hedge fund. I would like to get some advice on the process. There seems to be some posters here who are credible, and best of all, advice here is free. Thanks in advance for any insights you have to offer.

I have been trading and investing my own funds for about 2.5 years now. The first 1.2 years were done under a family account and won't be useful for raising capital. As of 1/2011, by returns are as follows:

2011: 87.2% return. Max drawdown (based on monthly returns) of 5.0%. Profits of 330k
2012 YTD: 36% return. Max draw down of 4.1%. Profits of 200k.

These returns have been achieved with generally market neutral strategies, although currently I intend to maintain a long bias. Monthly returns show a R squared of 0.04 against monthly returns of the S&P500. Despite low draw downs, high returns are somewhat concentrated around a few great months, which is I know is incrementally negative. StDev of monthly returns is 10.8%.

I have about 5 years of experience working on Wallstreet doing primarily fundamental research of US equities as an associate level generalist. I've worked at two small hedge funds that are not well known, but legit. My age of 28 is on the young side and may work against me.

Investment approach -

Primary doing l/s based on fundamental research. I have been opportunistic and employed some short term "trading" strategies, but these have also been based on fundamental analysis. These short term strategies account for a good chunk of returns, although I am focusing more on the long term portfoilo more nowadays.

Raising Capital?

I hope to start raising capital in 1 to 4 years. I do not intend to raise capital now, partly because I don't think my trackrecord is long enough, but also because I'm very busy right now with research. I am becomming increasingly comfortable with my investment process, and I believe I can continue to achieve 50% + returns with low draw downs. Initially I will be satisfied raising at least 1mm. Although the fees from 1mm will be fairly small, it seems a worthwile start given my belief that I will continue to produce positive risk adjusted returns and attract greater investor interest over time. This is assuming the 1mm is from one client- I'm not interested in the hassle of raising 1mm from various small investors (friends and family). I obviously hope to raise more, but I don't know what is realistic at all. If i can't raise 1mm, I will continue to manage my personal capital.

I'd love to hear what I can realistically hope to raise in one or two years assuming I can maintain these results, and also considering my relevant, but not impressive, professional background. If the answer is zero, what kind of track record will it take to raise a few mil?

Also, some have recommended going the way of a managed account. Ideally I'd like to set up a fund, but I can understand that investors are reluctant to send a few mil to a stranger, despite how trustworthly I look in person. I suppose a separate managed account in addition to your own account will be just as good for building a track record when audited? Some potential conflicts of interests with respect to how to execute trades do immediately come to mind. Some of my shorter term trades will need to be executed quickly, and I'm not sure how it will be possible to have these trades executed at the same time if I'm managing multiple accounts.

is this guy real or is he living in Lala land ? I see all kind of red flags about his story and his expectations of the future

Those performance numbers are highly suspicious,

 

[Butterfly]

Any performance numbers that doesn't follow the strict GIPS standard should be regarded as fraudulent or wishful thinking