How to Set Up Your Own Hedge Fund Author: Hannah M. Terhune is an attorney with Capital Management Law Group, PLLC, based in Washington, DC. Miss Terhune specializes in setting up hedge funds, incubator funds, master/feeder funds, forex funds, commodity pools and other financial products of interest to the alternative investment community. Miss Terhune and her legal team can be reached at (202)498-7533 or firstname.lastname@example.org. © Copyright 2006 – Hannah Terhune 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 thewheel.” 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 acollective 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. Portfoliosof hedge funds may include fixed income securities, currencies, exchange-traded futures, over-the-counter derivatives, futures contracts, commodity options and other nonsecurities investments. 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 inequities 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 apercentage 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 investorssuch 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, whichinvest 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.
Legal Documents to Set Up a Hedge Fund To start a hedge fund, documents are prepared to establish the fund and the management company as legal entities. Thesubscription agreement and the operating agreements for the fund and the management company also must be drawn up. One document that is of particular importance is the private placement memorandum (PPM), since potential investors generally rely heavily on the information that the PPM provides. The PPM is an extensive document individually created for each hedge fund. Although there are no...
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