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How to start a Hedge Fund |
Traders and money managers often dream about one
day running their own
hedge fund, managing large sums of money, and competing head to head
with
the world’s top traders. For many, though, this dream remains
unfulfilled,
because they do not know where to begin and do not want to squander
their
resources “reinventing the wheel.”
The first step toward setting up a hedge fund is getting a better grasp
of what
exactly a hedge fund is. Hedge funds often are compared to registered
investment companies, unregistered investment pools, venture capital
funds,
private equity funds, and commodity pools. Although all of these
investment
vehicles are similar in that they accept investors’ money and generally
invest it
on a collective basis, they also have characteristics that distinguish
them from
hedge funds and they generally are not categorized as hedge funds.
Unlike a mutual fund, a hedge fund is not registered as an investment
company under the Investment Company Act and interest in the fund is not
sold in a
registered public offering. Hedge funds can trade in a wider range of
assets than
a mutual fund. Portfolios of hedge funds may include fixed income
securities,
currencies, exchange-traded futures, over-the-counter derivatives,
futures
contracts, commodity options and other non-securities investments. |
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As the name indicates, hedge funds initially specialized in hedging and
arbitrage
strategies. When Alfred Winslow Jones established the first hedge fund
as a
private partnership in 1949, that fund invested in equities and used
leverage and
short selling to “hedge” the portfolio’s exposure to movements of the
corporate
equity markets. Although hedge funds today often employ far more
elaborate
hedging strategies, it is also true that some hedge funds simply use
traditional,
long-only equity strategies. Hedge funds are also well known for their
fee structure, which compensates the
adviser based upon a percentage of the fund’s capital gains and capital
appreciation. Advisors at hedge funds often invest significant amounts
of their
own money into the funds that they manage.
Although they still represent a relatively small portion of the U.S.
financial
markets, hedge funds are a rapidly growing investment vehicle. The
growth is
fueled primarily by the increased interest of institutional investors
such as
pension plans, endowments, and foundations seeking to diversify their
portfolios
with investments in vehicles that feature absolute return strategies –
flexible
investment strategies that hedge fund advisers use to pursue positive
returns in
both declining and rising securities markets, while generally attempting
to protect
investment principal. In addition, funds of hedge funds, which invest
substantially
all of their assets in other hedge funds, have also fueled this growth.
This growth
has not escaped the notice of the SEC, which has expressed concerns
about the
potential impact of hedge funds on the securities markets.
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