How to Open a Hedge Fund

Hedge funds usually invest in both the domestic and international markets.

Hedge funds are one of the big financial stories of the last few decades. They are unregulated investment vehicles that speculate on the stocks, bonds and commodities. The unregulated nature of hedge funds means that managers can take any position they like in their trades, increasing the potential for equity return, but also elevating the risk of major losses. As such, they are a volatile investment vehicle, usually for those with large amounts of capital, and certainly not for the faint-hearted!

Instructions

1. Hire a lawyer. A good lawyer is essential to any hedge fund. He will help you draft the documents required to define your business, draw up legal agreements and assist with incorporating your new venture.

2. Define the parameters of your hedge fund. You and your team --- you are likely to want, at least, an analyst, a trader and a financial officer --- must determine the scope of the fund's operation and the rights and duties of each player. You will also need to determine how any profits are distributed amongst the members of the company, usually as a percentage depending on their degree of influence on the profitability of the fund, so that the manager is likely to receive the largest percentage as he makes the trading decisions. You should also give a name to your fund that reflects its remit and rent suitable office premises from which to work. Your lawyer will then draw up an operating agreement for all members to sign.

3. Draft a private placement memorandum, which is the document with which you will try to attract investors. It will set out the investment strategies you intend to pursue, the types of equities and bonds you will invest in, the growth objectives you hope to achieve and the professional details of those involved in the operation of the fund.

4. Incorporate your hedge fund in the appropriate jurisdiction. This may not necessarily be the state in which you are based; some hedge funds are incorporated offshore, in places such as the Cayman Islands. You will need to complete an Article of Incorporation with the Office of the Secretary of State for your chosen jurisdiction and pay a fee. Your lawyer can assist with the incorporation process.

5. Raise capital. Once you have a PPM and incorporation in place --- giving you legitimacy as a financial firm --- you can solicit investment capital. Your lawyer may be able to help you identify suitable investors to approach with your PPM. You may also want to hire a PR expert to "sell" your product to the right people. You may need to find a seed investor initially. This is an investor who gives you the capital to start trading so that you can demonstrate to other investors a record of performance. However, in return for backing an un-tried outfit, a seed investor is likely to demand a high percentage of return from the company.

6. Secure respectable brokerage. Once you have capital to trade, you need to find a brokerage agency who is willing to facilitate your trading. All trades need to be recorded and facilitated through a recognized broker, often one associated with a large bank (having the backing of a major bank may also be helpful when attracting investors). Brokers will also be able to assist you with complex trades, such as derivatives. Now you can start trading as a hedge fund and, hopefully, make lots of money for you and your investors.

Tips & Warnings

• Hedge funds that manage more than $30 million worth of assets must register with the Securities and Exchange Commission.

References

• Money Science: How to Start a Hedge Fund
• Vanity Fair; How to Start a Hedge Fund; Keenan Mayo
• CNN; Start Your Own Hedge Fund; Marcia Vickers