Hedge Funds - General Information
In the securities world, the term "Hedge Fund" does not necessarily imply any use of "hedging" as commonly understood; for example where commodity traders use options to "hedge" a commodity position.
Presently, in the securities world the term "hedge fund" refers to any type of Private Investment Company operating under certain exemptions from registration under the Securities Act of 1933 and the Investment Company Act of 1940. "Hedge Funds" are often referred to as "alternate investment vehicles" and are tailored to the needs of sophisticated, high net worth private investors. A Hedge Fund is generally structured as a limited partnership having a general partner responsible for the investment activities and day-to-day operation of the fund, and limited partners who are the investors supplying capital but not participating in trading or operations of the fund. The limited partners have limited liability. That is, their exposure to loss is limited to their investment. The General Partner has unlimited liability and is liable for the activities of the partnership. The General Partners principals limit their liability through the use of a corporation or limited liability company as the General Partner. (Of course, the principals cannot limit their liability from the application of the anti fraud provisions of the Federal Securities Laws.) All of the investors' capital is pooled and is utilized by the General Partner or Investment Manager to implement its trading or investment strategy.
Turn Key Hedge Funds, Inc. makes it easy to start a Hedge Fund. The following is a list of benefits of starting a Hedge Fund with us:
One point of contact/coordination.
Reduce number of outsourced personnel
Reduced training time for back office management
Increased decision-making authority in the field
Tailored customer communications
Reduced contracting and administrative costs
Consistent service levels
Access to highest quality personnel
Timely response and follow-up inquiries
Timely resolution of conflicts
Reduction in service variability
Focus on improved performance
Improved company focus through strategic outsourcing
Value-added services such as training and management reporting
Start up hedge fund managers should take notice that the Securities and Exchange Commission (SEC) recently adjusted for inflation the dollar-based qualification tests allowing an SEC-registered investment adviser to charge performance fees. Under the new test, compensation based on investment performance may be received only from clients that meet or exceed the new "Qualified Client Test" which has increased the net worth requirement for "Qualified Client" status from $2 million to $2.1 million, effective August 15, 2016. However, the alternative test, which is based on the client's assets under management with the adviser, was not changed and remains at $1 million under management.
You have been spending your waking hours at your computer buying and selling stock through your on line broker. You have developed your own trading strategy and you have been successfully trading through your broker. After much deliberation, you decide that you are now ready to start up your hedge fund. However, the start up hedge fund manager needs to consider more than just the cost of execution when selecting a broker. One common error is using the broker that only provides retail customer “settlement date” statements and does not provide statements of realized and unrealized gains and losses. Although “settlement date” statements are fine for the individual retail customer managing his or her own account, it is an impediment to the professional hedge fund manager. The start up hedge fund manager quickly learns that for tax purposes and to properly account and report to investors, not providing monthly statements realized and unrealized gains and losses; and, providing only “settlement date” information is insufficient.
If you are starting a hedge fund and are registering as an investment adviser you should make sure that you have a written code of ethics. The SEC requires that all advisers registered with the SEC must adopt and enforce a written code of ethics reflecting the adviser’s fiduciary duties to its clients. Start up hedge fund managers will find it a useful operational and compliance tool. The startup hedge fund manager should consider SEC’s guidance as applicable to state registered funds as well.
Hedge Funds - Non Public Offerings:
Hedge Funds not coming within the regulatory relief from the general advertising prohibition under the "JOBS Act," are "Non-Public Offerings." The private offering exemption prohibits Hedge Funds from making any public offering. Therefore, Hedge Funds are prohibited from general advertising and generally secure investors through word of mouth, consultants, registered representatives, brokers or investment advisors. Hedge Funds have investors that are either "accredited investors" or "qualified purchasers." In general, the Federal Securities Laws define the terms "accredited investor" and "qualified purchaser" in terms of minimum asset and income threshold that must be met before they qualify to be investors in the Hedge Fund. Since the Hedge Fund generally limits investment to "accredited investors" or "qualified purchasers" both of whom are required to meet certain minimal asset and/or income thresholds, the Fund Manager or administrator must gather background information on potential investors to determine whether they meet the minimum requirements to be "accredited investors" or "qualified purchasers." By making a non-public offering to certain kinds of investors, (accredited investors or qualified purchasers) the investment vehicle will be exempt from registration requirements of The Securities Act of 1933 pursuant to the safe harbour provisions of Rule 506 of Regulation D. Where the investment vehicle is limited to no more than 100 investors, and otherwise complies with the safe harbor provisions of Regulation D, such an investment entity is exempt from the extensive regulation pursuant to Section 3(c)1 of The Investment Company Act. Section 3(c)7 of The Investment Company Act offers a similar exemption to private investment companies with "qualified purchasers" as investors. As an unregulated entity, the Hedge Fund Investment Manager is free to undertake greater risk on more volatile positions thereby exposing investors to potential substantial profit as well as substantial losses.
Typically, Hedge Funds provide for the payment of an Incentive Allocation or Performance Fee to the hedge Fund Manager/General Partner. Performance Fees range from 20% to 40% depending on the strategy employed by the Hedge Fund Manager. Typically, the Performance Fee provides for a "high water mark" structure which provides that incentive fees are paid only to the extent that the fund continues to meet or exceed the "high water mark." Additionally, typical Hedge Funds include Management Fee of 1% to 2% of all assets under management.
Hedge Fund - Managers and Styles:
Generally there are two kinds of Hedge Funds. On the one hand, there are the huge worldwide funds operated by charismatic managers such as George Soros. On the other hand, there are small boutique-styled Hedge Funds identified with a particular segment or investment strategy. The Fund Manager's expertise, experience and background in recognizing investment opportunity will dictate that fund's particular niche. For example, there are the "Biotech Hedge Funds" which are managed by experienced and highly qualified investment managers who may also hold advanced degrees in science and medicine. There are "Tech Hedge Funds" specializing in the technology sector managed by individuals having specialized experience trading in that sector. With the emergence of day trading and the availability of the trading technology, a number of floor traders and brokers are leaving the traditional brokerage and exchange venue to participate in the computer screen trading phenomena.
The boutique "Hedge Fund" typically relies on the particular skill and expertise of the Investment Manager or Trader. The highly specialized Investment Manager may utilize a "Sector" style of investing focusing on a particular industry or economic sector. Conversely, an Investment Manager utilizing a "Market Neutral" style will maintain a portfolio of securities which are generally 0.5 short and 0.5 long. Some Investment Managers utilize a "Value" investment style based upon assets, cash flow and book value; while other Investment Managers follow the "Emerging Markets" style and invest in emerging and foreign market equity and debt. "Trading" funds utilize an opportunistic investment style taking advantage of market trends, events and opportunities for short term profits. Each Fund Manager develops and uses a particular investment style that is unique to the experience, expertise and personality of its manager.
Unlike Hedge Funds, Mutual Funds raise money publicly; are highly regulated by the Securities and Exchange Commission, the Internal Revenue Service and other agencies; and offer investment diversification and are restricted from purchasing many types of derivative instruments, leveraging, short selling and other kinds of transactions.
Unlike the Mutual Fund Managers, the Hedge Fund Manager generally invests in the fund that they manage and participate in profits as well as risks with their investors. Unlike the Mutual Fund fee structure (which is determined on assets under management) the Hedge Fund Manager receives incentive allocations on performance.