I brought an outline of my strategy and my performance returns to a friend of a family friend, who supposedly had access to many hedge fund and rich clients; he was not impressed. I had decided to move into professional money management at a difficult time (early 2003) and most investors had lost a lot of money over the past few years and claimed to have become conservative. The friend wanted my returns audited and then he would consider helping me raise capital in exchange for money. I figured this is the way the industry worked, so I found a local accountant familiar with stock trading and spent a college semester�s tuition to have my many thousands of trades audited.
After a few weeks of patiently explaining short sales to my accountant who was familiar with stock trading, the audit was complete and the numbers looked good. The numbers looked too good to the friend who might help me raise millions of dollars and he wanted to know the ins and outs of my strategy or else he would not be comfortable promoting me as a professional money manager.
Thought #1: If you consistently beat the market, you will face endless questions about whether or not you are a fraud.
And so I decided after a couple of meetings to form my own hedge fund and take my chances raising capital. I had very few business connections and most of my friends and family were not wealthy enough to contribute to my enterprise. Only my performance could attract new money.
I did not want to start a mutual fund because I knew they had too many limitations (could not use leverage or short-sell stocks). I researched hedge funds nonstop for months. I discovered what it takes to start a hedge fund and found the startup costs were surprisingly cost effective.
Before the emergence of discount hedge fund startup shops over the past few years, I found the template for offering documents and lawyer fees could exceed $50,000, more along the lines of $100,000 when it is all said and done. Since then, several hedge fund boutiques have appeared, offering their administrative and startup services at cost effective rates.
I was surprised there were so many forms to fill out and fees to be paid. There is an incredible amount of paperwork and compliance involved with the LLC and LP for hedgefunds.
Thought #2: Try to get investors from only a few states (your home state) because each state that you have an investor in, you must register with state and registration costs a varying amount of money.
The ink was barely dry on my letters of incorporation when it hit me. I had been distracted by my hedge fund research and setting all my companies up, and I was not being as astute with my trading and investing. Trading and investing is all about focus and subconsciously, I had diminished my focus while initially trying to raise capital for my fund.
Thought #3: Focus on your trading and investing first; do not schedule meetings during market hours.
Now I would not be able to have that magic whole number in front of the millions of dollar under management; I was going to have to put a dreaded decimal point and some other numbers before the word million.
Meanwhile my fund administrator convinced me to switch brokers since discount online brokerages were simply not used once you have reached the hedge fund world.
The difference between the two brokers was incredible. At my administrator�s recommended brokerage, I did not have my usual electronic trading platform (I was told it would be ready within weeks) and the traders executing my orders when I called in simply did not provide good executions. I called to complain about the executions and yet they brushed me off. They placated me by saying their new online software was only days away from completion. (Almost twenty months later, the software is still almost ready). One brokerage allowed me electronic access and I became friends with one trader who somehow always got me better executions on my large orders.
The brokers knew I was comparing fees, and trying to find the most cost effective solution for my fund�s investors. This is a zero-sum game, the value I save in broker fees is passed on directly to my partners, and are reflected in the returns. I asked for commission reductions based on the trading that I did. It quickly became clear which broker I wanted to stay with when the broker without electronic access incredibly upped their commission on a trade without telling me. When I called to complain, the broker told me he knew I was paying more at the other broker and therefore he was entitled to the same rate. He was mistaken on top of the fact that he just had taken matters into his own hands without consulting me. The difference in price on that one trade was only a few bucks, but I flipped out based on the principle of the matter.
I had started chatting regularly with one an industry commentator and he referred to me another broker that was perfect for short selling. His software, cost, and short-selling list blew away the competition so, I dropped my other broker.
Thought #4: Do not feel bad about changing brokers if they are ripping you and your clients off. They are not girlfriends, they are always offering better deals.
The CEO of the brokerage I was dropping called me to see what they had done wrong and ask why I was closing my account. I could not understand why it was so important my small fund stayed with their firm that supposedly had billions of dollars in accounts. My commissions with them barely touched into the thousands.
Every fund manager should price as many brokers as possible that fit the fund�s strategy. There are many brokers who may trade for themselves, but mainly exist and make money by simply taking a share out of your online trade commissions. They make their money from trading commissions, not from making successful trades or investments�that�s the bottom line. There should be no reason to have to pay an individual representative of a major brokerage when you are using simply their online software, but that is the way it is. I am very skeptical when dealing with these people, and I do not feel bad about getting in an argument with them.
So, my account performance moved back into the range of my previous years, crushing the overall market and my investors were very happy. Yes, my parents and a few of their friends were elated. Yes, after months of solid performance that consistently beat the market, I still had underachieved in the area of capital raising. I realize now that it will take a lot longer than I originally anticipated, but I have made so much money in the past and I am confident in my skill as a manager, and that is what gives me the faith to go forward.
Thought #5: The larger the �nest egg� stake the manager has, with the initial startup–the better.
I had moved to New York City because I figured it was the epicenter of making investor contacts. I had met many potential investors and many in my industry, but no matter how many times people said they were interested, no checks were written.
One interesting meeting was with a senior manager of a major mutual fund company who had heard about my performance. I met him at his luxurious house and we proceeded to discuss my situation. After a few hours of listening, he told me I was very smart and that I should focus on raising capital by changing my strategy around to suit potential investors. He told me in his years of experience, investors are skeptical of high returns and want very low volatility. I told him in my years of outperforming the market I could care less if people accepted my strategy and I believe people will respond to performance. He has been right so far, but my fund is still outperforming the market and he is probably not.
Thought #6: Focus on what works for you and do not change to accommodate others.
I attended a few alternative investment conferences and handed out plenty of business cards. I even got to be on a panel discussion thanks to my fund administrator�s connections, but my speech sounded na�ve and unpolished compared to the more experienced managers and veteran marketers who attended. In fact, I was mesmerized by one particular fund marketer who had grown his fund exponentially over six months. I do not think he said one useful fact during his presentation, but he delivered an eloquent speech and several people, including me, came up to him afterwards. We discussed marketing my fund, but he charged some ridiculous amount per hour of work spent on my case and he said his results would take time to appear and were not guaranteed.
I had sent out dozens of offering documents to interested parties and yet the rate of follow-through was ridiculously minimal.
Thought #7: Raising money does not come easily for the emerging manager.
There are very few reasons for individuals to take a chance on a new operation unless they have known you for years or if your performance warrants the added risk of a startup. People in large firms will not want to take a chance on your fund because of the minimal track record, lack of transparency of positions, and the volatility of returns. Their job is on the line with any investments they make, and if they mess up�they are fired. For the most part, they would rather under perform than risk losing anything. This is what Warren Buffett once called the �institutional imperative.� It is a herd mentality, where these �institutional lemmings� move together, not necessarily doing what is the best or smartest thing for their clients. There exists what appears to be an intelligent decision to go with a high performing emerging manager, but still an outside chance of looking like a fool. No manager will make that decision, because they will be fired if things don�t turn out like they anticipated. Similarly, these emerging managers� are fired if they do not make long strings of positive yearly performance.
My fund is listed on many hedge fund databases, but Hedgeco.net and Hedgefund.net have lead to most information requests by far. After a year of listing my fund, I have had over a thousand hits on my fund�s web pages.� I have received more interest on Hedgeco.net and it seems like they taking the lead in adding new features every day to make the marketplace more efficient.� In fact, many third party marketers have contacted me through these websites.�
Some third party marketing firms have contacted me. One marketer said he was showing my PowerPoint presentation to potential investors the day after I emailed him and he would get back to me. He has yet to get back to me. Another marketer said he would work for my fund, but wanted 50% of the incentive fee I would be paid on any profits I made on the investment. Another wanted 30% of the incentive fee. With those kinds of figures, it would take me too long to make it worth my effort even if my returns continued to trample the market. I wanted to pay an upfront finders� fee to them, but they knew that is not where the big money is. I understand their dilemma; why should they risk their reputation on a startup fund for only a small payoff?
But there was an individual that said he had the connections and was willing to take a job full time with me without taking more than 10% of the incentive fee. I just wanted him to introduce my fund to his connections because I have just a handful of family and friend connections that were wealthy enough to be potential investors. He demanded an exorbitant yearly pay for his services, and would not guarantee he could raise the millions he promised, but he was optimistic after reading my presentation and looking at my returns. I was happy yet skeptical that he did not want to know more about my strategies. It took weeks for him to �write out some contracts� and he was using his lawyer. I was optimistic after having talked to him several times. But when I looked at the contracts, I was dismayed.
He wanted to focus on completely overhauling my marketing by creating new expensive presentations and we were going to use the guy who designed the Oakley logo to design an incredible logo for me that would surely attract investors! I am no marketing genius, but somehow I felt a new logo was not the problem and the Oakley guy was little out of my price range. He also wanted to do a traveling road show to his contacts to present my fund so I could stay put and focus on my trading. Somehow paying for him to jet around the country without me was not my idea of a good investment. I told him no and I designed a simple logo on Microsoft Paint. I get many compliments on my logo each week.
Thought #8 Lawyers, Brokers, Software, and other service providers want to line their pockets with you and your investor�s money. Be cautious.
Final Thought:
Don�t chase money–let it come to you. If you get money invested that is fickle, hot or “scared money” it doesn’t help you in the long run. This industry is tough for the little guy because there are many promises and very little follow through. Not being able to advertise is very difficult and you must rely on contacts and networking for capital introductions. You have to be willing to give up your strategy and your pay, and even your returns, to run big money. I chose the other path; focus on what I do best and be content to make some decent money while waiting for more opportunities. I figure there will always be people who want to raise money for me and they will only multiply with time and with outperforming the market. I do not want to compromise my trading and investing style and I accept the fact that it might take years for investors to come. Only performance and patience will create the path of success�a journey I am willing to take, so help me God.
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