Learn the basics of a hedge fund

If you’re looking into how to start a hedge fund, you’ll find it can be an exciting endeavor for you and your investors’ financial future. A hedge fund is an investment vehicle whereby investors combine their money to engage in various investing strategies to produce profits and control volatility and risk.

Hedge funds are called as such because they engage in "hedging" which means they attempt to control risk and volatility through holding positions that move in opposite price directions. These complex strategies make hedge funds different from many other investment funds available.

Hedge funds will do this through derivative securities such as options, forwards, and futures.

  • By hedging, the fund will be able to protect its core capital funds in case downturns in a security or the market happen.
  • Hedge funds will also often use various strategies in order to increase returns, such as borrowing funds, utilizing additional derivatives, engaging in currency trading, and participating in public and private investments from around the world.
  • There are thousands of hedge funds in the world, with more starting every year.

By controlling your own hedge fund, you will have the responsibility of investing other people's funds and assets on their behalf with potentially profitable outcomes for you and the clients.

If you have experience in finance, starting a hedge fund may be a way for you to start your own business and leave behind the larger institutions.

The mechanics of creating a hedge fund begin with creating and registering the hedge fund's "general partner" company. Investors participate in the hedge fund through being limited partners with a private partner.

  • Because of the complexities and risks of a hedge fund, it is a bit more difficult and confusing to form than a corporation or LLC.
  • Creating a hedge fund requires you to understand and comply with a variety of investment and securities regulations, with significant penalties for non-compliance.
  • These investment laws vary significantly by country, and even by state.
  • The investment laws also might vary depending on where your potential investors are located, how you reach out to investors, what securities you invest in and the number of investors you have.
  • Usually hedge funds only allow participation by sophisticated investors, which is defined by those with over a million dollars to invest.

Distinguish between hedge funds and mutual funds

Hedge funds look like mutual funds due to both being collections of money overseen by a manager. However there are many important ways these funds differ, and it is important to think about them when deciding which to start.

  • Hedge funds face far less regulation than mutual funds do, and thus are able to partake in a greater, and often riskier, variety of investing strategies and products.
  • Furthermore, hedge funds also often borrow money, bet against securities using shorting, and engage in higher-risk products and strategies that mutual funds are not allowed to.
  • A hedge fund will be required to disclose to potential investors in a private placement filing what kinds of strategies they hope to engage in and the risks involved.
  • Mutual funds and hedge funds also differ in how accessible they are.
    • A mutual fund can be purchased by nearly anyone, if it is publicly registered and has its documents approved by the SEC.
    • In contrast, hedge funds are filled through private fund raising with investors who are accredited, which means they have significant income to invest.
  • Hedge funds will also often require their participants to lock themselves in for a period of time, which means they cannot retrieve their funds. In contrast, investors in mutual funds can usually sell their shares whenever they want.

Mutual funds and hedge funds also pay their fund managers differently from one another. A mutual fund will pay its fund manager a fixed percent of the fund's total value under management every year. In contrast, a hedge fund will also receive a set fixed percentage fee of the assets but also get a share of any profits the fund makes, usually set in the industry at about 20%.

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