Establishing a performance record

[stubarny]

Hi everyone,

I'm looking to set up a long-only hedge fund, build up a performance record and then look for investors in about 3 years time. This will be funded by about GB£1million of my money from selling a business.

My questions are:

1) Is £1 million enough to be credible? Will potential investors suspect that I'm setting up dozens of funds and cherry picking the best? If so are there any solutions?

2) I have no professional trading experience. How big a problem will this be with investors (assuming I succeed in getting 2-3 years of good performance results)?

3) I am extremely keen to go my own way and avoid all the stress and career bias that comes from being an employee. My strategy would have a 10 year investment horizon and will experience the occational bad year. I'm judging the fund's performance on long term (10yr) reliability for beating the market and long term (10yr) returns. I'm not very interested in yearly volatility - are there like minded investors out there or are many people chiefly concerned with Alphas and Betas over 1-year periods?

4) How important is it that I become CFA certified?

Thanks for all your help!

S

 

[fifty2aces]

Apologies for not really being able to answer any questions, but what differentiates a long-only hedge fund from a mutual fund? Would it not just be an expensive mutual fund?

2-3 years of performance record doesn't really sound like a lot, unless you're trading on a pretty short-term basis. (The number of trades is probably more relevant than the length of time, as larger sample size > lower variance > less chance of good result due to luck)

With no professional experience, you're pretty much relying on performance record, so it'll need to be robust. How much trading have you done so far, and what kind of returns have you been getting? What instruments, leverage etc? Will your strategy easily scale up to a multiple-million pound account?

Also, it's potentially quite a bit harder to trade a huge account - if you have £1000000 kicking around, and make good returns, why not just trade for yourself, rather than having to satisfy investors?

 

[stubarny]

Thanks fifty2aces,

> what differentiates a long-only hedge fund from a mutual fund? Would it not just be
> an expensive mutual fund?

I'm just trying to keep admin costs to a minimum - my understanding is that mutual funds are more expensive to administrate than hedge funds.


>2-3 years of performance record doesn't really sound like a lot, unless you're trading on >a pretty short-term basis. (The number of trades is probably more relevant than the >length of time, as larger sample size > lower variance > less chance of good result due >to luck)

It would be a concentrated portfolio of about 6-8 stocks, so not many trades!


> Also, it's potentially quite a bit harder to trade a huge account - if you have £1000000 > kicking around, and make good returns, why not just trade for yourself, rather than
> having to satisfy investors?

Becuase if 3-4% net worth is taken as a salary then that gives an annual income of £30,000 to £40,000. So in the long run I think I need to manage other peoples money.


Thanks guys, I really appreciate any input you can give.

Regards,

S

 

[DaxDestroyer]

Hi everyone,

I'm looking to set up a long-only hedge fund, build up a performance record and then look for investors in about 3 years time. This will be funded by about GB£1million of my money from selling a business.

My questions are:

1) Is £1 million enough to be credible? Will potential investors suspect that I'm setting up dozens of funds and cherry picking the best? If so are there any solutions?

2) I have no professional trading experience. How big a problem will this be with investors (assuming I succeed in getting 2-3 years of good performance results)?

3) I am extremely keen to go my own way and avoid all the stress and career bias that comes from being an employee. My strategy would have a 10 year investment horizon and will experience the occational bad year. I'm judging the fund's performance on long term (10yr) reliability for beating the market and long term (10yr) returns. I'm not very interested in yearly volatility - are there like minded investors out there or are many people chiefly concerned with Alphas and Betas over 1-year periods?

4) How important is it that I become CFA certified?

Thanks for all your help!

S

My experience is, that 1 million is seen as a serious investment, especially if you are not Bill Gates
Most people look for at least 2 to 3 years and logically look exactly on a bunch of numbers, so your 10 year approach might be too long, to get money on board.
You should make sure from Day 1 that you certify it. And which broker you use. There are brokers looking for guys like you to seed you even quicker.
You really should talk about all that with an expert in that field!
Every qualification is good, but what you really need depends on, where you want to get the money from.

So to be honest Look out for an real expert, better 2 or 3. Guys you pay and who take responsibility for their "tips".

All the best for your venture!

 

[fifty2aces]

Thanks fifty2aces,

> what differentiates a long-only hedge fund from a mutual fund? Would it not just be
> an expensive mutual fund?

I'm just trying to keep admin costs to a minimum - my understanding is that mutual funds are more expensive to administrate than hedge funds.


>2-3 years of performance record doesn't really sound like a lot, unless you're trading on >a pretty short-term basis. (The number of trades is probably more relevant than the >length of time, as larger sample size > lower variance > less chance of good result due >to luck)

It would be a concentrated portfolio of about 6-8 stocks, so not many trades!


> Also, it's potentially quite a bit harder to trade a huge account - if you have £1000000 > kicking around, and make good returns, why not just trade for yourself, rather than
> having to satisfy investors?

Becuase if 3-4% net worth is taken as a salary then that gives an annual income of £30,000 to £40,000. So in the long run I think I need to manage other peoples money.


Thanks guys, I really appreciate any input you can give.

Regards,

S

I reckon you'd have to do much better than 3-4% per year to attract investors to a long-only hedge fund - really you need to offer reasonable returns with low volatility + limited market correlation (e.g. arbitrage type funds) or large returns (certainly much more than 5%).

What has your personal trading performance been like? (percentage return, period of time, number of trades, max drawdown, sharpe ratiio etc.)

I think there would be limited statistal significance in 6-8 picks over 3 years, but then investors probably won't know that - the problem is whether you'll be able to continue outperforming the market - you need to be confident that you haven't been lucky so far.

 

[stubarny]

I reckon you'd have to do much better than 3-4% per year to attract investors to a long-only hedge fund - really you need to offer reasonable returns with low volatility + limited market correlation (e.g. arbitrage type funds) or large returns (certainly much more than 5%).

What has your personal trading performance been like? (percentage return, period of time, number of trades, max drawdown, sharpe ratiio etc.)

I think there would be limited statistal significance in 6-8 picks over 3 years, but then investors probably won't know that - the problem is whether you'll be able to continue outperforming the market - you need to be confident that you haven't been lucky so far.

Sorry I was unclear - the 3-4% I mentioned was what I would be willing to cash in per year from a portfolio to live on, and that £30-40K per year isn't that great despite the headline £1million sounding like a lot of money.


I have backtested over a 30 year period and traded for 3 years. Total annualised return is 18% with max drawdown of 35%. When I say 'hedge fund' I'm just talking about a private investment fund. There's no shorting or leverage being used. The total number of trades over the 30 yr period was about 50 - so they are long term investments in solid growing companies, that just happen to be undervalued for some (irrational) reason. Consistency of beating the S&P500 (most investments are in US markets) was 83% on rolling 10yr periods. So you can see why I'm anxious whether investors would appreciate the high return/risk characteristics for the long term horizon when the return/risk ratio on an annual basis is quite poor (volitility is high due to a concentrated portfolio). The average sharp ratio over the 33 yrs has been 0.5 so you can see my problem!

Thanks very much,

S

 

[fifty2aces]

Sorry I was unclear - the 3-4% I mentioned was what I would be willing to cash in per year from a portfolio to live on, and that £30-40K per year isn't that great despite the headline £1million sounding like a lot of money.


I have backtested over a 30 year period and traded for 3 years. Total annualised return is 18% with max drawdown of 35%. When I say 'hedge fund' I'm just talking about a private investment fund. There's no shorting or leverage being used. The total number of trades over the 30 yr period was about 50 - so they are long term investments in solid growing companies, that just happen to be undervalued for some (irrational) reason. Consistency of beating the S&P500 (most investments are in US markets) was 83% on rolling 10yr periods. So you can see why I'm anxious whether investors would appreciate the high return/risk characteristics for the long term horizon when the return/risk ratio on an annual basis is quite poor (volitility is high due to a concentrated portfolio). The average sharp ratio over the 33 yrs has been 0.5 so you can see my problem!

Thanks very much,

S

Ok, well four problems then:

1) 50 trades is not a huge number - it's not bad, but you probably want more to reasonably gauge your profitability.

2) The problem with backtesting is the potential for curve-fitting - it might satisfy you, but it's too easy to create a system which works really well in the past for investors to take you seriously, and you need to make a good number of actual trades (or at least real-time paper trades) to confirm profitability.

3) You say that your system is long-term, but you want to use performance over 3 years (a comparatively short term) to attract investment.

4) Your sharpe ratio is low - I'm not 100% certain, but I believe the S+P500 has a ratio of about 0.6 - why would people pay you fees to underperform?

 

[charttrainerdotcom]

Long only hedge fund? There is no such thing. Either it´s a hedge fund or it´s a long only fund. In this specific case it´s a stock picker long only fund.

I think 1m GBP is very reliable. If your track record is good and there is unsystematic risk, youre on a great track. Why don´t you go for a managed account before trying the official and expensive fund management thing?

 

[Bagehot]

Financial services are part talent and part networking/contacts. One can debate the various proportions, but the one thing that the people have in common that I know who have set up their own funds is that they 'know people'. This opens doors in terms of getting new money in, getting in front of potential investors, etc., but it also means that even if you're moving outside your direct area of expertise, then you have a reputation, are known to be trustworthy, that your word is your bond, etc.

You don't say what your background is, but if it's away from the City then I think you will find it very, very difficult to break in, particularly as your own seed capital is not that great, and that your track record is relatively short - I'm not sure that your backtesting will be considered particularly seriously because of the 'curve-fitting' tendencies previously mentioned - particularly given the volatility of your approach.

If you're doing it properly and setting yourself up with the regulators to manage client money you'll need at least 3-5x the capital you're putting in at the start to cover your overheads - can you realistically tap up 3rd party investors for that amount?

Finally - I'd be a bit concerned about being able to sell your strategy. When I started out you could maybe get away with a long-term strategy which considered 1-yr performance 'short term'. If you're name is Buffet, you probably still can. But for anyone else 1-yr is performance is 'long-term' even in blue-chip pension funds these days. Also whether 6-8 positions would be considered sufficiently diversified, as your Sharpe ratio indicates.

 

[lifegauge]

Long only hedge fund? There is no such thing. Either it´s a hedge fund or it´s a long only fund. In this specific case it´s a stock picker long only fund.

I would like to correct you here if I may.

There are many hedge funds that are long only. Do not take the "hedge" in hedge funds literally. For a better definition, I think you should read what HedgeCo.net has written in "WHAT IS A HEDGE FUND?"

 

[lifegauge]

To the original poster, stubarny,

I will try to answer your questions one at a time:

1) Is £1 million enough to be credible? Will potential investors suspect that I'm setting up dozens of funds and cherry picking the best? If so are there any solutions?

While investing your own money to get it started is usually what a new fund manager does, I believe it does not give you any more credibility than what you already have. Like someone mentioned before me, getting a track record is the best solution. When managing a hedge fund open to receive investments, it is as important to show that you are able to manage the business aspects of it as it is crucial to manage the portfolio.

2) I have no professional trading experience. How big a problem will this be with investors (assuming I succeed in getting 2-3 years of good performance results)?

Assuming you are able to manage your "fund" for 2-3 years with positive performance on reasonably volatility, you should be able to find someone who will be willing to put in some seed money in exchange for equity of your company (or fee discounts, or some other rebates).

3) I am extremely keen to go my own way and avoid all the stress and career bias that comes from being an employee. My strategy would have a 10 year investment horizon and will experience the occational bad year. I'm judging the fund's performance on long term (10yr) reliability for beating the market and long term (10yr) returns. I'm not very interested in yearly volatility - are there like minded investors out there or are many people chiefly concerned with Alphas and Betas over 1-year periods?

You will not be able to escape or even lighten the stress as an employee by being the manager of a hedge fund. Having to worry about performance, investor relations, regulations, etc on top of your mortgage just makes it more challenging than living life as an employee. There are certainly investors who are willing to ignore the short-term downside risk and volatility. Any intelligent investor will know that your strategy determines it all, and if you put that through clearly, you should have no problems finding a like-minded investor.

4) How important is it that I become CFA certified?

Important for what? Important for who? For credibility again? I do not wish to get into the argument of the importance of a CFA certification, but I will leave it as something that's good to have.

On a separate note, someone started a topic "How do Hedge Funds get around the 90% Failure Rate?" on EliteTraders forums. While the content within that thread is not completely accurate, it does provide a good read.

Someone else mentioned in this thread that you should try to find another person to work with in this venture, and I think that might be a good idea. If you could look around and see if there is already a hedge fund where you are located that is running a similar strategy to what you intend to do, give them a ring and ask if they will consider having you as a partner in the firm. You bringing GBP 1 million will open most doors, at least for a chat. Learn from those guys and reconsider.

 

[charttrainerdotcom]

Another idea: try a managed account structure before setting up a fund. Faster, cheaper and it allows you to prove wheather or not you are able to raise funds. Hope that helps! Good luck!

 

[stubarny]

Many thanks everyone for your help before.

Given that 2008 involved holding down a day job, running two businesses and passing the CFA level 1 exam I thought it was best to hold off starting an investing track record until now.

I'm considering taking the 'managed account' route and becoming GIPS verified. Despite lots of reasearch the practicalities of this seem unclear to me. I'd be very grateful if people in the know could clarify a few things for me:

1) Does this simply involve me setting up a limited company, and then working for the investment management company as a director/employee to invest my personally owned share portfolio? (i would be the only client to begin with)

2) Would the share portfolio be owned directly by the client (myself) rather than by the invesment company?

3) If I have to pay personal income taxes, capital gains taxes on my investments would this affect the recorded investment perfomance of the investment company? i.e. am I right in assuming there is no need for me to setup offshore vehicles to maximise the company's investment performance track record?

4) Can I do this without being regulated (I live in the United Kingdom)? If not how time consuming/expensive is regulation and how do you go about it? - this is a big worry because if I fall foul of the regulators I expect this goes on the public record and my reputation is permanently shot?

5) the costs of going the 'managed account' route? Is it simply the cost of registering a limited company and filing the annual accounts? With myself as the only client obviously admin work would be negligible.

6) Is it realistic for me to aim to start trading before the beginning of 2009? (I'd love to have a full calender year under my belt in a year's time).

Many many thanks for your help!

Stubarny