Hedge funds are the pooling of assets. The main purpose is to invest in different strategies to both generate positive returns for investors and manage risk. Investing in hedge funds is usually available to sophisticated investors with large amount of assets, in most cases, assets over $1 million. Hedge funds mostly use complex strategies in an effort to maximize returns. These strategies usually includes but not limited to investing in the following securities:
In some cases, investments are supported by leverage (borrowed money). In addition, decisions at times are based on global economic trends.
Some of the most popular strategies use by hedge funds includes the following:
Establishing the funds
The following are the usual steps taken in establishing a hedge fund:
1. Hire a law firm – it is always advisable to hire a firm that has experience in this industry both in establishing an onshore fund, and an offshore fund – the Cayman Islands for example. The firm should have an understanding of the various structures available for the strategy you are seeking to pursue, and the appetite of the expected investors in the fund.
2. Putting together a team – this usually includes individuals with experience in the industry. However, and for small startup funds, a fund administrator such as Advanced Fund Administration can provide valuable advice in this regard based on the number of entities they provide services to in the industry.
3. Naming the funds – most investment managers will seek to use a name that represents the fund strategy, or one that reflects stability and expertise.
4. Address tax matters – in the USA, funds are required to obtain a Federal Employer Identification Number (FEIN) from the Internal Revenue Service (IRS). Your tax advisor in most cases than not will assist, however, this is a relatively simple process.
5. Register as an investment advisor – in the US, investment advisors with less than 15 investors associated with the fund, do not have to register with the Securities Exchange Commission (SEC), however, it is always advisable to do so.
6. Create an entity to act as the General Partner – while a hedge fund can function as a sole proprietor, it is always advisable to create a corporation as a partner to limit your own liability - this entity will be your investment advisory company. In the US, most fund managers uses a Delaware entity, while in the Cayman Islands, and other offshore jurisdictions, an exempt company, a LP, and recently LLC is used. The Cayman Islands now have in place LLC legislations which may now be the new preference.
7. Investment Advisor Representative (IAR) – after registering the fund as a Registered Investments Advisor, you must register yourself as the advisor to the fund.
8. Registering the fund prospectus whit the Securities and Exchange Commission (SEC) – Hedge funds don’t typically register with the SEC but do register the “Prospectus” of the limited partnership to investors. With respect to offshore funds, and in particularly, the Cayman Islands, funds with less than 15 investors, or a closed ended fund does not have to register with the Cayman Islands Monetary Authority (CIMA).
Putting the fund together
1. Prepare fund documents – with the help of your attorney, create a set of documents that explain the fund’s goal and terms of investments. This is usually referenced as the “Prospectus” or the “Private Placement Memorandum” (PPM). This document seeks to protect the fund and also establish, or assigning losses to investors. An experiences attorney will advise on language and approach.
2. Seeding the fund – In most cases than not, and Investment Manager (IM) will seek an “anchor investor” or someone to seed the fund. In some cases, seed funds are from family and close friends.
3. Promoting the fund – promoting the fund is always advisable, for a small fund with certain financial limitation, promotion of the fund is usually done by the IM who will focus on the investment opportunities supporting the reason why the fund was launched in the first instance.
4. Finding a Prime Broker – a prime broker is usually used to execute trades, and in some cases arrange leverage for the fund. Most major bank provide prime brokerage service.
5. Hire a fund administrator – Fund administrators can be a key third party service provider to the fund. It provides for credibility in that the NAV is calculated independent of the IM. Furthermore administrators can assume some of the duties normally performed in the back office of the IM, and in most cases than not, reduce cost. Investors, especially institutional investors appears to invest in funds with independent administrators.
For additional information please contact: