What if you throw a hedge fund party and nobody comes?
Maybe you’ve found a niche strategy nobody has thought of yet. Maybe you’ve built a financial model that looks like the Goldman Sachs’s income statement. You’ve got commitments from reputable third parties to handle all your back-office affairs. You lack only one thing: experience. Before you start calling yourself a hedge fund manager, you need a fund to manage. You need to get at least person to trust you with their money.
That sounds like a daunting proposition, but there are several thousand people who have accomplished this before you. If you can learn from their lessons, you could speed up the process of going from MBA to AUM.
The first step is to eat your own cooking. Nobody is going to hand over money to somebody who doesn’t have his own money at risk. That’s necessary but, in itself, insufficient.
“In order to build a track record, we’ll encourage a manager to set up what’s called an incubator fund, which is a fund platform that allows them to manage only their own capital,” says John McCorvey, founder of Stonegate Global Fund Services and Blue Flame Capital Management in Atlanta. “At some future point, call it six months, twelve months, down the road … we then convert that incubator fund to a full-blown hedge fund and dot the I’s and cross the T’s with respect to the regulatory and compliance elements that they need and they can go out and market their fund accordingly.”
A model portfolio is not enough, McCorvey advises.
“If the manager does not have an existing track record or if they have a model portfolio, then what we typically do is set up an incubator fund for them,” he says.
In order to go live at that point, a fund needs a full array of private placement memoranda, subscription agreements and other offering documents, as well as a marketing packet. The six- to twelve-month rule of thumb is not inviolate. The conversion can occur whenever the fund manager believes he or she can attract outside investment.
That could conceivably be earlier, but, then again, it might not. It’s not about you being ready for the money; it’s about the money being ready for you. According to financial education web site Mergers & Inquisitions, this kind of short track record could attract funds of funds or family offices or high net worth individuals, but most endowments, pensions and other institutions might not look at you until you’ve been around the circuit for three years or more.
Before you start knocking on Fidelity’s door, though, it’s probably best to keep it close to home.
“[Traditionally] managers will solicit investors that they have a preexisting relationship with,” McCorvey says.
Also, McCorvey advises managers to keep in mind the newly relaxed general solicitation rules enshrined in the JOBS Act.
At this point, most newly minted barons of Wall Street bring in money from family, friends and neighbors. This might sound easy, and maybe in some cases it is. But let’s be clear: you can lose strangers’ money and they’ll just take their business elsewhere going forward. But unless you want every wedding, funeral and holiday dinner for the rest of your life to be even more awkward than those things already are, you’d better produce.
But even when you open an account and deposit your last straight-job bonus check, your best friend’s tax refund (for current purposes, let’s just assume your best friend is still single) and your cousin’s 529, that doesn’t make it a hedge fund.
Simply put, before your friends, family and neighbors put in a dollar they have to be rich. Maybe the JOBS Act will permit you to put your pitch book on Instagram and your one-pager on a stadium blimp, but that doesn’t mean you can take just anyone’s money. Hedge fund capital still has to originate with institutional or otherwise accredited investors.
But what if you’re not from such a privileged background? It all starts with networking. You yourself probably know some likely investors or you wouldn’t be taking this plunge. And you never know who the other people in your life know. Even if they can’t put their own money in your fund, that doesn’t mean they can’t introduce you to somebody who can.
The next ripple out would be to retain a third-party marketer, whose whole job is handling capital introduction for hedge fund managers; Mergers & Inquisitions suggests they might not touch you until you have at least $5 million AUM. McCorvey also recommends looking into listing with industry databases, which help investors down-select funds that meet their current investment needs.
At that point, it’s all about increasing your exposure and, of course, continuing to live up to your track record. Once you’re known for high returns, then that becomes all that matters.