Over the last two years, investors have pulled speculative capital out of risky assets at an unprecedented rate. In fact, analysts estimate there is currently billions of dollars of investment capital on the sidelines as investors are still unsure of the long-term economic outlook for the United States economy. Most of this speculative capital that is on the sidelines is earning investment managers and qualified investors close to nothing.
The Federal Reserve, of course, has set interest rates at an absurdly low level, which means investors who have capital in very safe, low-risk investments are earning virtually nothing. Capital has begun flowing back into higher risk investments such as hedge funds this year as the global economy strengthens. One specific market where hedge funds are continuing to grow is the foreign-exchange market.
The forex market has exploded over the last 10 years, as average daily turnover has increased from roughly $1.5 trillion in the early 2000’s to $4 trillion today, and this figure is expected to double in the next 10 years. The forex market is attractive for many reasons, but chief among them for larger hedge funds is the deep liquidity and cheap transaction costs. These two features significantly reduce the cost of doing business for most hedge fund managers.
In the forex (FX) market, however, the potential for the loss of funds is very real. The FX market is a 24 hour market that never stops, and it moves extremely fast. The high leverage available in this market leads to quick, sharp profits, but it can also lead to destabilizing losses in a short amount of time. If a forex trader or investment manager is looking to start a hedge fund, there are several key steps he needs to take.
Build a Track Record
This is the key to building a fund. Hedge fund development is largely based on an investment manager’s ability to raise capital from investors, and it is very difficult to raise capital from qualified investors without at least a two year track record. Although some investors will not require a full 2 years, the 2008 Crisis has caused most investors to be much more risk-averse in their decisions, and they oftentimes will want to see a solid two year record. Remember, your volatility curve needs to be very smooth as well. Gains are not all that matter—the gains have to be made in consistent manner.
Get an Audit
Most qualified investors will want to see fully audited trading records in order to assure that the results are real and accurate. This hedge fund audit will cost thousands of dollars and should be done by a reputable auditing firm who carries weight in the investment community.
Pass Your Series 3 & Register With NFA
The National Futures Association regulates forex trading activities in the United States, and all forex hedge fund managers need to pass the Series 3 and pay a small registration fee in order to be in compliance with the NFA.
Create a Disclosure Document
Once you pass your Series 3 and have your strategy developed and tested, you are ready to begin raising capital. However, you will first need to hire a hedge fund law firm to help you write your disclosure document. This is an NFA-regulated document that fully discloses all risks to any investors. It includes detailed information on your personal background, investment approach and risk management parameters.
It is imperative that you hire a reputable law firm to help you ensure that you are compliant with all the regulations that govern this market. Not being compliant can be costly and even lead to criminal charges.
Managing a forex hedge fund is risky, however, there are definitely qualified investors who are willing to take increased risks in order to possibly earn higher returns.
If you follow the rules, trade successfully and communicate clearly with your investors, you will build a solid reputation in the investing community, which is essential to starting a hedge fund.
About the Author
This post was written by guest contributor Jennifer Gorton from Forex Traders. The opinions expressed in this post are those of the author and do not represent the opinions of this site, its owners, sponsors or affiliates.