I am Hedge Fund partner and it's not that great

[Andy Nguyen]

The author is a partner in a London hedge fund. Interesting read if you dream of setting up your HF in the future. Forget about it if you don't get $100M

It has fallen to me to cure people visiting this site of a grave disillusion: becoming a partner in a hedge fund is no panacea for life’s ills.

I know this, because I am a partner in a Hedge Fund. I helped set it up and I now spend all day talking to the prime brokers (“PBs”), the administrators and the investors that keep the ship afloat. Here are a several thoughts for you.

Unless you have access to $100m of sticky seed cash, forget it. The prime brokers won’t even look at you. The days of starting a fund with $30m and a wing and a prayer are over.

Since the “crisis,” banks have massively tightened up their criteria.Even if you have access to $100m you will want to have more than one PB to provide your leverage. Several of my friends had their funds shut down by their sole PB bank pulling their leverage at the most inconvenient moment and effectively shutting the fund. Most PBs give you one month’s notice; signing a new PB deal from a standing start in less than three months is impossible; closure is inevitable. In reality you need more like $150m; $100m in your first PB and $50m in one that you are stringing along.

Then we come to investors. These are notoriously tricky creatures. They won’t want to be more than 10% (usually 5%) of your total assets under management, but at the same time, they won’t want to write you a ticket for “just” $5mm; you are just too small for them.

This will mean that growing your assets is very slow. Remember this is a numbers game, it is the Management Fee (the 2 of the 2&20) that turns the lights on; your seed money won’t be paying you 2%, so you need to get your AUM up as quickly as possible.

You also need to bear in mind that 18 months of track record is the big performance metric that HF investors are slaves to and you don’t have that.

So now you have the money. Next you have to deal with the lawyers, the administrators, and the regulator. The first two are just money...and lots of it.

Budget on $100k-$150k to get the initial structure set up and all the legal agreements in place. Next you need to get regulated. Bitter experience of FSA applications suggests it takes nine months before you get approval. That’s a long time to keep all the plates spinning and all the parties and constituencies interested in your little scheme.

Bear in mind that all this time you are not getting paid.

Worse than this, you are writing cheques left right and centre for everything. A plush office in “Hedge fund Alley” is going to set you back £60 a square foot and require a five year lease. Fitting out a reception, meeting rooms and a dealing room for 10 people will set you back at least £300k.

Your new investors will also want to do due diligence on your middle and back office, your compliance procedures and your processes; this will require a raft of extra bodies in the admin part of your expensive office space clacking away at their computers and adding to your overhead.

You are not going to become rich overnight. The early years will be tough! You have high overheads, low AUM and a raft of new regulation coming in (AIFMD, via your investors Solvency 2), which is going to make the landscape tougher. You will be putting in long hours to create the performance necessary to get your AUM up to a viable level.

You will not be buying country estates, islands or yachts anytime in the near future. There have been plenty of days I have looked enviously at my ex- colleagues in the banks and longed for my days as a wage slave.

If any of this sounds like self valedictory “pulling up the ladder behind me” stuff I really don’t intend it to be so. I just think that someone needs to quash the idea that starting a new hedge fund is a panacea for the woes of being a bank wage slave. The highs of owning your own business are great, but the lows are twice as low....

http://news.efinancialcareers.co.uk/newsandviews_item/newsItemId-31274

 

[goldski]

Since the “crisis,” banks have massively tightened up their criteria.Even if you have access to $100m you will want to have more than one PB to provide your leverage. Several of my friends had their funds shut down by their sole PB bank pulling their leverage at the most inconvenient moment and effectively shutting the fund. Most PBs give you one month’s notice; signing a new PB deal from a standing start in less than three months is impossible; closure is inevitable. In reality you need more like $150m; $100m in your first PB and $50m in one that you are stringing along.

This is very true and the he is right about $150M. That is the magic number right now for anyone starting a hedge fund on the street. If you don't have 150M it is absolutely pointless to even think about a HF. Banks are very picky about this in the US too. My two friends are starting a hedge fund and have been working on it for the last 8 months and plan to launch in 2 months. One of them was even a trader/MD at an american BB for more than 10 years. I have been helping them out with some trivial things on the side. It is VERY hard with the new regulations to set up a hedge fund. He went to his own bank for PB and they basically have been ordered to not give any new hedge fund attention that have less than 150 AUM. There are ways around it as you don't technically have to register as a HF but if you want to be unregulated HF is basically the only designation out there as CTA/AM/MF are all heavily regulated.

 

[David Rappaport]

Interesting post.
Starting a fund still sounds amazing.

 

[goldski]

And the 2/20 framework. Forget about it. It's 10% of returns for the first 2 years if you're lucky.

If you're the next Henry Paulson and make 20% returns in your first year then maybe you will take home 300-400K in salary for first 3-4 years if you are a hedge fund of 4-5 people. Most quant developers at established hedge funds and prop trading firms make more than that.

 

[Andy Nguyen]

Yet, when I read personal essays from aspiring applicants to MFE programs who are just graduating with a bachelor degree, I often see things like "I want to go to study in your program, and after 5 years on Wall Street, I want to bring that experience back to (insert an emerging market name) and open my own hedge fund."

It's hard to take these kids seriously when they haven't worked in the industry for a day and talking about opening their hedge fund. The days of setting up your HF from the basement when you are on a hot winning streak are long over.

 

[Connor]

For me this article highlights the diverse skill sets to start a hedge fund at the individual or group level. It isn't enough to be a quant god if you (or a partner) can't handle getting investors, working with brokers, managing an office, the legal side, etc. From a career planning standpoint, you really need to plan to move around some and get some experience handling different aspects of the business; sitting at the same desk looking at Excel for half your life won't get you the skills you need to start your own fund, you need to be proactive.

 

[DominiConnor]

Excellent insight, thankyou.

I think it illustrates an important business principle. He says that the HF business is not as easy & profitable as it was.

That decline is a constant in finance and any business.

If you find a way of making money that is easy and profitable, then by all means take the money.
But never think that it will last very long.

 

[HyperVolatility]

Thanks for the article, however, I have to agree with Dominic.
Thinking that starting up a business from scratch would be as easy as dreaming of it is simply naive !!!

The insights are very informative because they clearly list all the efforts that are required in order to create a new fund but I doubt that the long procedures, the huge amount of money that you need and the fact that you are not going to get rich any time soon are specific to HF.....................those things apply to any start up and they are particularly true if your business is a financial one!!!

Easy ways to make money become easily obsolete and you gotta change your strategy if you do not want to close down...............if you do not update your skills/techniques you will go bust............it would be like selling physical goods using marketing campaigns from the 60's...........your competitors are going to eat you alive !!!

 

[Joy Pathak]

The problem with this is not the one about actually making money and the regulations. The problem is raising $150M. How is someone to raise $150M. You better hope you either become the right hand man of Soros to get that kind of funding or spend the next 15 years as a Sales Trader or a Trader at a bank and hope to build a relationship so strong that people will be willing to give you $150M with no audit-able track record.

 

[Ken Abbott]

Firms do seed capital investments regularly. It happens often with funds set up by former employees. From scratch, it would be very hard.

 

[bob]

A couple other thoughts on this:
Not to shill shamelessly for my current employer, but there are mature service offerings in the market that allow funds to outsource most of their middle- and back-office functions so they can concentrate on what they do--managing assets--rather than administrative headaches. These services scale with NAV and reduce overhead, and even many large, established asset managers are now choosing to have a third party "lift out" a lot of their administrative functions to improve efficiency. These services aren't just limited in availability to large funds, however; there is a real desire to sign small funds, since out of any large population if even one or two are very successful, the revenue growth for the service provider can be quite substantial.

It's easy to blame regulation for the increased barriers to entry, but I think even in the absence of oversight the market would be heading this direction. 2008 and its consequences have made prime brokers highly conscious of their counterparty exposures, but more than that I think the alternative arms of many large asset managers, pension funds, university endowments, sovereign wealth funds, and so on are driving the impulse for more disclosure and more mature controls. These investors command very, very large amounts of capital and have overseers who want to know that risks of all sorts are being appropriately measured and managed. These investors have the need and the leverage to influence the behaviors of the managers to whom they allocate capital.

Further, there are distribution channels for funds opening up that never existed before to any large degree. Services have come along that are almost like 401(k)-type investment management tools for institutional investors, where the possible investment choices are not mutual funds but hedge funds. The pooling of assets may allow smaller allocations to certain funds than would be possible if dealing directly with the manager, and can sometimes also lessen the liquidity hit of fund lockup provisions. There is a real advantage to funds who can get onto these platforms, which will in turn also give the platforms bargaining leverage in how the funds do their business.

It seems to me that all this will lead to funds competing not just on returns and risk characteristics, but also on fees. There are already funds out there that have broken with the typical 2 & 20 / high watermark fee structure, which while it will probably always exist for the flagship funds, will probably come to be seen in time as a relic of the "good old days" of hedge funds as these vehicles become more commercialized. The mystique of hedge funds has already, I'd have to say, worn off to a very large degree.