How to Start A Hedge Fund | The Motley Fool (2024)

If you've come up with a market-beating strategy and have a good track record of outperforming the market, you may be thinking about starting a hedge fund. Hedge fund managers receive considerable compensation for their performance, and the tax benefits are great for high earners.

But a short track record of outperforming the market in your personal trading account isn't enough to start a hedge fund. You'll also need to assemble a team to make sure that you establish and operate legally and register with all the necessary parties. You'll need to market your fund and raise money to invest. And you'll need to run a business on top of managing the hedge fund's investments.

If you think you're up for the challenge, here's how to start a hedge fund.

How to Start A Hedge Fund | The Motley Fool (1)

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What is a hedge fund?

A hedge fund is an investment company that pools together funds from investors. It works similarly to a mutual fund, but there are a few key differences.

Properly structuring an investment company as a hedge fund exempts it from certain registration requirements under the Securities Act of 1933 and the Investment Company Act of 1940. As such, hedge funds are able to use all sorts of investment strategies in order to earn outsized returns for their investors. In order to maintain that status, however, hedge funds can only accept investments from accredited investors -- defined as individuals with a liquid net worth exceeding $1 million, or $200,000 in annual income.

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Why would someone start a hedge fund?

Managing a hedge fund has the potential to be extremely lucrative. The standard fee structure of 2 and 20 provides a 2% management fee for all assets under management and a performance fee of 20% of the profits each year. If there are no profits, the company still collects the 2% management fee. When we're talking about hundreds of millions of dollars, the money adds up fast.

Of course, in order to get to $100 million-plus of assets in your control, you'll need a network of high-net-worth individuals. You'll need to prove to them that you're a better steward of their money than they are. You'll also need to be marketing the new fund in order to expand the business, and don't forget you'll need to invest all your investors' money, too.

If that sounds like a job you're capable of pulling off, then maybe you should start a hedge fund.

How to legally start a hedge fund

1. Define your strategy

1. Define your strategy

The first thing you need to do is define your investment strategy as clearly as possible. Make sure the strategy is replicable and scalable. It can't rely on certain policies or economic environments to succeed. Hedge fund investors want to see consistent gains. The strategy you used to grow your personal account over the past decade may not work over the next decade and with an account with tens of millions of dollars.

If you have a strategy that's repeatable in any market, that you can scale by investing more time into research, and that's easily understood by investors, then you have something you can work with. Common hedge fund strategies include: long/short equity positions on undervalued/overvalued stocks, merger arbitrage where markets misprice securities slated for mergers, buying distressed companies, and algorithm-driven quantitative approaches.

Once you have a viable strategy for your hedge fund, you're ready to actually start a business.

2. Incorporate

2. Incorporate

Hedge funds are typically set up as a limited partnership where the hedge fund manager is a general partner and all the investors are limited partners. You could also set up an LLC or use some other structure. It's best to consult a professional on the right structure for your hedge fund.

Once you determine the proper business structure, you need to register with the secretary of state in the state you wish to incorporate and file your articles of incorporation with the state. Additionally, file for an employer identification number (EIN) with the IRS, which you'll use for further registrations and taxes.

As a hedge fund manager, you'll likely want to protect yourself by forming an LLC. An LLC will protect your personal assets if the hedge fund declares bankruptcy or gets sued (although you'd still be personally liable if you committed wrongdoing on behalf of the company).

3. Complete the proper registrations

3. Complete the proper registrations

Once incorporated, you need to register the new company with the Securities and Exchange Commission (SEC) and the regulatory bodies of the state where you incorporated. You'll also need to register the company as an investment advisor.

Additionally, you need to register as an investment advisor, and any other representatives of the hedge fund manager will as well. That requires you to pass the Series 65 exam administered by the Financial Industry Regulatory Authority (FINRA).

Finally, you'll need to register the hedge fund offering with the SEC using Form D. You need to do this for every state where you'll be offering the fund. Form D is specifically for exempt securities such as hedge funds.

A good lawyer will ensure that you cross your t's and dot your i's when it comes to filing all the registrations necessary to set up your hedge fund.

4. Write your investment agreement

4. Write your investment agreement

Before you go out and market your new hedge fund, you'll need a clear investment agreement to show prospective investors. The investment agreement will include details such as:

  • Your fee structure:What's the expense ratio? Do you have a performance fee? The industry standard is a 2% management fee and 20% performance fee, but there's been pressure on lowering fees over the past decade.
  • Minimum commitment:Is there a minimum amount of time or money an investor must commit? Many hedge funds require at least $1 million and a one-year commitment, sometimes more.
  • Distributions:Will you have set periods where investors can request distributions, or will they be able to take distributions by providing notice 30, 60, or 90 days ahead?

Again, a good lawyer will be invaluable in making sure your investment agreement covers everything you need.

5. Get your team together

5. Get your team together

Beyond the aforementioned lawyer, you'll also want to assemble a team of key service providers.

  • A broker offering prime brokerage service: Being able to make trades or borrow cash and securities are essential to running a hedge fund. A broker can help facilitate the core activity of a hedge fund. Hedge funds need prime brokerage services for lending securities from other institutional investors and facilitating margin loans from commercial banks.
  • Auditor:Hedge funds need their results audited if they want their track record to hold any weight when marketing to potential investors.
  • Administrator:As a hedge fund manager, you want to focus on trading. An administrator can handle the day-to-day tasks of making everything else in the business run smoothly.

6. Market yourself

6. Market yourself

Before you can actually manage people's money, you need to sell them on why your fund will be a better fit than managing their money themselves or allowing someone besides you to do it.

As a hedge fund, you're only able to accept investments from accredited investors. An accredited investor holds $1 million in liquid assets or has an income of $200,000 per year (or $300,000 per year with a spouse). If you have a network of friends and family who fit that description, start with them. If not, you'd better be a really good networker and salesperson.

Be sure you comply with all laws and regulations when marketing. Consult your lawyer.

Show your prospective investors your (audited) track record from using the same strategy you'll use for the hedge fund. Explain why the strategy will continue to work in the future. Then ask for their money.

7. Launch

7. Launch

Once you have enough investors, you can launch your fund. Link up the brokerage account and start trading.

Even after launching, the hard work probably isn't done. In fact, it could be more difficult. Now you have to manage the fund, continue to market it, and attract new investors in order to expand the business.

Related investing topics

Hedge Funds vs. Mutual Funds: What's Better?While both offer investors managed portfolios, they are very different from each other.
What Is a Hedge Fund?When wealthy investors put their money together to beat the market.
How to Invest in Index Funds in 2024Index funds track a particular index and can be a good way to invest. Get a fast introduction to index funds here.

Is it worth it?

Starting a hedge fund is a lot of work. It'll take a lot of your own time and money just to get things set up, and then you have to do the real work of getting others to invest with you and investing their money. The payoff could be substantial, but you could also end up wasting a lot of time and money.

The Motley Fool has a disclosure policy.

How to Start A Hedge Fund | The Motley Fool (2024)


How much money do I need to start a hedge fund? ›

With respect to establishing a U.S. hedge fund, average hedge fund startup costs range from $50,000 to $100,000, and first- year operational costs usually total $75,000 to $150,000.

Can I start my own hedge fund? ›

In order to start a hedge fund in the United States, two business entities typically need to be formed. The first entity is created for the hedge fund itself and the second entity is created for the hedge fund's investment manager.

What is the minimum amount to invest in a hedge fund? ›

The fee structure for these funds comprises two components. A management fee typically below 2% and a performance fee of 20%. Therefore, to invest in hedge mutual funds, the minimum investment fund required is ₹1 crore per investor, while the entire fund must have a minimum corpus of ₹20 crore.

What is the minimum net worth to invest in a hedge fund? ›

3 In exchange, the Securities and Exchange Commission (SEC) requires a majority of hedge fund investors to be accredited, which means possessing a net worth of more than $1 million and a sophisticated understanding of personal finance, investing, and trading.

What is the 2 20 rule for hedge funds? ›

The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.

Can one person run a hedge fund? ›

Build Out Your Team. A hedge fund is not a one-person show and it's important to have the right support in place to keep things running smoothly. For instance, you'll need a prime brokerage to facilitate the most essential activities of the fund, such as trading securities.

Who Cannot invest in a hedge fund? ›

You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds. Typical investors include institutional investors, such as pension funds and insurance companies, and wealthy individuals.

Is BlackRock a hedge fund? ›

BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.

What is the survival rate of hedge funds? ›

First, the hedge fund mortality rate in this sample is estimated at 8.43 per cent per year which is twice the size of those reported in mutual fund studies. We find that 59 per cent of hedge funds at the start of the sample do not survive the full sample period.

What is the ROI of a hedge fund? ›

Most hedge and private equity funds target a net IRR of 15% for their investors (after fees). This provides their investors with a meaningful premium over historical average stock market returns of 8%.

Is Berkshire Hathaway a hedge fund? ›

No, Warren Buffett does not have a traditional hedge fund. His company, Berkshire Hathaway, operates more like a holding company that invests in stocks and entire companies for the long term.

What is a good size hedge fund? ›

Table 1: The Universe of Hedge Funds Broken down by Size
SizeAuMTotal Number of Funds
SmallUS$10-100m (average US$37m)4,654
Mid-sizedUS$101-500m (average US$232m)2,004
Large>US$500m (average US$693m)787
Super-large10 largest hedge funds (average US$7,721m)10

Can you make millions at a hedge fund? ›

The money is a big draw as well: if you're at the right fund and you perform well, you can earn into the mid-six-figures, up to $1 million+, even as a junior-level employee. The top individual Portfolio Managers can earn hundreds of millions or billions each year.

Which hedge fund has the highest return? ›

Billionaire Christopher Hohn's TCI led the annual ranking by 2023 returns, which were $12.9 billion after fees, while Citadel, Millennium Management and D. E. Shaw, all multi-strategy firms, were the top three hedge funds by lifetime gains.

How hard is it to run a hedge fund? ›

With a little bit of capital, it is relatively easy to start a hedge fund. However, implementing risk controls, growing assets, hiring staff, and running the organization as a profitable business while producing positive performance is very challenging.

Is it hard to run a hedge fund? ›

With a little bit of capital, it is relatively easy to start a hedge fund. However, implementing risk controls, growing assets, hiring staff, and running the organization as a profitable business while producing positive performance is very challenging.

How do hedge fund owners make money? ›

Hedge funds make money by charging a management fee and a percentage of profits. The typical fee structure is 2 and 20, meaning a 2% fee on assets under management and 20% of profits, sometimes above a high water mark. For example, let's say a hedge fund manages $1 billion in assets. It will earn $20 million in fees.

How do small hedge funds make money? ›

Hedge fund strategies involve investing in debt and equity securities, commodities, currencies, derivatives, and real estate. Hedge funds are loosely regulated by the SEC and earn money from the 2% management fee and 20% performance fee structure.

How long does it take to start a hedge fund? ›

It will generally depend on how prepared the manager is and how fast the attorney's can work. It will also depend on whether the manager will need to be registered as an investment adviser. In general though, assuming no registration is required, a sponsor should be able to get a fund up and running within 6-8 weeks.


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