Starting up a new hedge fund today is a challenge unless it’s a spin-off from sizable and established funds. Nevertheless, despite the difficulties of raising capital, it is still possible to be successful.
If you want to be successful, it’s worth taking some advice from Warren Buffet who said “It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.” Wasting valuable skills on time-consuming, mundane tasks is not a good idea. Hiring staff, implementing all the necessary risk controls and regulations as well as running a successful hedge fund takes up so much time and energy. It’s better to outsource some tasks to experts who already have successful solutions, giving you time to focus on what’s important.
Why is it becoming more difficult?
It’s tough to establish a new hedge fund today. It’s becoming increasingly difficult to raise capital, fee expectations are lower and keep being squeezed, regulatory pressures are mounting, and operational costs have increased. In the face of all these difficulties, establishing an audited track record of high yields is not easy. You need at least two to three years of high yields to attract serious investors.
What can you do to differentiate yourself and survive?
Emerging hedge fund managers are competing fiercely to raise seed capital. You need to assess what will make you attract the attention of investors. What is critical is your core value proposition, a good marketing strategy, and an audited track record. You will need enough funds to survive while you build up a credible track record and raising capital is a major challenge. Most new hedge funds start off with capital raised from family and friends or an individual of high net worth, so they can start creating a track record.
A successful track record
Never underestimate the importance of building up a track record. It’s essential to be regulated while building your track record and applying for an FCA license can now take as long as18 months, which is a big delay. Increasing regulatory burdens also require more infrastructure which in turn increases operational expenditure.
A small team cannot expect to cope with all the demands of setting up and running a new hedge fund, especially with increasing regulatory burdens. Regulatory set-up and reporting is one area that can be outsourced. Other areas of outsourcing may be compliance and risk management, IT and operational risk, legal and structure and even office and facility set-up. By outsourcing many processes to a platform solution, you will be able to demonstrate that your fund complies with all the necessary regulations, has satisfactory risk controls and the operational technology is in place.
Investors feel confident when they know that a third-party intermediary platform is looking after their investments. The business risks are limited and controlled, making the institutional investment in a fund possible. Investors know that the platform won’t risk its other investor relationships when one small fund defaults.
If you outsource compliance, you can become an appointed representative (AR) within a few weeks and establish a regulated track record while waiting for the FCA. If you outsource IT and office infrastructure to an organization that is compliant with AIFMD and MiFID 11 outsource trading, you will minimize execution costs and save money and time on trading costs that affect your bottom line.
Risk systems, middle and back office, operational procedures, producing performance reports and detailed analysis can all be outsourced. Your IT should be private and cloud-based. Having it run by experts in the field will mean that regulatory stipulations are met, and efficiency is maximized. Managing technology is a profession and it’s much better to outsource this if you’re starting a new firm.
In-house seeder fund capacity and a good capital introduction team
Large prime brokers are often not able to find you the seed capital, despite their promises. They often simply can’t justify the time and do not have the contacts for a new hedge fund.
A key part of your success will be to find in-house seeder fund capacity combined with a capital introduction team who focuses on emerging funds and works on a results basis. This team will already have established relationships with investors and understand what they require.
Integrating with a specialized prime broker gives you the advantage of an aggregated platform serving multiple smaller hedge funds. This is important at a time when small funds are struggling to gain access to global prime brokers. Basel 111 forces prime brokers to try and shore up their balance sheets so they may find they need to drop smaller clients who are just not profitable enough. Brexit has also had an effect and brokers who operate in the UK and Europe are able to obviate this effect.
Central to the services of a prime broker is custody of assets, access to financial and securities lending, execution of orders and portfolio reporting. A specialized prime broker has a platform bringing extensive offerings together that will help you to successfully establish and grow your fund