Five things to remember—or you can forget about rolling around in your millions
Congratulations! After working tirelessly for years on the buy-side or the sell side, or as a used-car salesman, you’ve decided to get rich by launching an investment management company and hedge fund in the world’s financial capital, New York City.
If ever there were a place to establish a hedge fund, it is here. City-based hedge funds control more than $1 trillion in assets, more than three times what second-place London’s do. Four of the top 10 global hedge funds have Big Apple ZIP codes. More than 50,000 people in the metro area are employed in the hedge-fund industry.
True, the timing does not seem right for such a move. Hedge funds are failing at an alarming rate, and many “experts” point to the fee structure and mediocre returns as reasons people pull their money out, as the city’s public pension fund are doing. After all, investors can get mediocre returns on their own without paying for a luxury product.
Fear not! Thousands of New York-based hedge funds still operate and more are established every year. An environment of lower returns across the board, excessive cash looking for a home and wealthy investors’ desire for personal advice mean there is still room for private funds. Plan carefully and align yourself with the right people and you can create a successful hedge fund. Of course, what you do after launch is another story, but let’s get it off the ground first.
Here are five things to focus on.
Define your investment strategy. With more than 9,000 hedge funds in the world, approximately half of which are here, the best way to differentiate yourself is to develop an investment strategy that not only utilizes your experience as a trader/analyst/portfolio manager/widget distributor, but also one that has at least some unique elements. Does the investment world need another long/short equity fund? Your initial reaction may be “no,” but perhaps your process has found a relationship between performance and certain metrics that no one else has noticed. This is going to be your identity in the hedge fund world. Find your niche—and be sure you are comfortable working within it.
Spell out your investment strategy in clear, concise language so that when investors read your documents (more about them in a bit), they’ll know what they’re buying in to and why it works. With most investors you only have one shot, and they are unlikely to bite if you’re not clear about what to expect from you. On the flip side, realize that not all investors (and their annoying advisers) will buy into your strategy, and even if they do, it may not fit into their investment profile. C’est la vie: The strategy is yours, not theirs.
Choose good service providers. Beginning with your attorney (and there are plenty in New York), you need smart people guiding you. You’ll need someone experienced in all aspects of creating and operating a fund, from determining its legal structure and that of the management company, to helping set terms the market will bear, to producing quality documents, to establishing a robust compliance program, to …. You get the idea. You need someone accessible to answer questions—or get the answers—and give honest assessments about what you’re doing. And is affordable. Not cheap, because cheap advice can be amazingly expensive down the road, but who gives you the most for your money. After all, clients are not your only investors; you’re investing in your business, too. Customers want to know you’re spending your own money efficiently before you start investing theirs.
After you have established professional relationships in the hedge fund startup world, tap into their network to find other quality, affordable service providers. Third-party administrators, prime brokers, accountants, auditors, outsource compliance programs, real estate agents, IT and infrastructure providers—all can help you make your business.
Need more support? New York City has plenty of fund administrative companies, research shops and small accounting firms, among others, to assist you in building a portfolio that appeals to investors.
Be unconventional with fees. Avoid the common “2 and 20″ structure (the manager collects a 2% management fee, no matter how the fund performs, and 20% of the profits, after a basic return known as the hurdle rate). This has earned the ire of analysts and become a turnoff for clients because it leaves investors at risk while the manager seems to dance all the way to the bank. They may not realize—or care—that the management fee is intended to keep the doors open, pay the electric bill and perform research. It’s simply money out of an investor’s pocket.
To show you’re willing to put skin in the game, reduce the management fee and consider a sliding scale when determining a hurdle rate and performance fee. The less money you take up front, the more confident investors will feel about putting money into your fund.
Keep communication lines open. Sure, you were accessible and sweet as pie when you courted you investors, but that’s only the beginning of the relationship. Send monthly updates about how the fund is performing, significant changes in the portfolio or strategy, and trends that could keep your fund ahead of the pack. Silence makes people nervous, especially when you’re holding their dough; make sure they know what’s going on and why. This is especially true when communicating with some of the wealthiest investors in the world, many of whom live right here.
Network. With so many hedge fund managers and investment companies right here in town, it can seem like you can’t go anywhere without meeting a trader, portfolio manager, financial adviser or Wall Street lawyer. Use that to your advantage—while some may be your competitors, one day they might be working with (or hopefully for) you. Some have been in your shoes and will want to brag about how they made it. Listen and learn at conferences, seminars, and over drinks at New York steakhouses.
By following these principles, will you create the world’s greatest private fund and roll around in your millions in the Hamptons? If that’s your goal, you’ve watched too many movies about rich Wall Streeters. But ignore the basics and you’ll redeem your investors far faster than you raised capital.