How to start a hedge fund

Ready to launch your own hedge fund? We take you through the steps.

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Are you an experienced financial advisor looking to strike out on your own? Are you willing to take risks and earn profits for yourself and your investors? Launching your own hedge fund could be the right venture for you.

Read this guide to learn more about all the licences, business structures and legal documents you'll need to get started.

What is a hedge fund?

A hedge fund is a managed pool of invested money. They are designed to protect, or "hedge", investments from market uncertainty, whilst generating healthy profits. Starting a hedge fund requires an expert understanding of finance and economics.

Hedging

1. Become qualified and get your licence

You must have an Australian Financial Service (AFS) licence before starting a hedge fund in Australia. An AFS is a legal licence issued by the Australian Securities and Investments Commission (ASIC).

To obtain the licence, you must:

  • Hold a bachelor degree that is approved by the Financial Adviser Standards and Ethics Authority (FASEA).
  • Pass the FASEA exam. The exam takes around 3.5 hours to complete and covers three competency areas. These include financial advice regulatory and legal requirements, financial advice construction, and applied ethical and professional reasoning and communication.
  • Complete at least one full-time professional year. This professional year should add up to at least 1,600 hours, of which 100 need to be structured training. You will be assigned a supervisor to create your professional year plan.
  • Fill out an online application and submit various documents to prove your eligibility for the AFS licence. The fee for applying is $1,522.
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    2. Choose a business structure for your hedge fund

    You will need to choose a business structure before you start your hedge fund. There are two common business structures for hedge funds in Australia, these include:

    • Trust. A trust is used when a group of people pool together a sum of money to make investments. The trust is managed by a designated fund manager who is appointed by the fund trustees. In Australia, a unit trust does not need to be registered with ASIC. However, the fund manager will need to have an AFS license.
    • Company. Unlike a trust, a company will need to be registered with ASIC. However, a company provides shareholders with some protection in case the company fails.

    Hedge funds are commonly structured as a trust due to tax benefits. A trust is handled as a "flow-through" entity for tax purposes by the authorities. This means that income is transferred directly to the investors.

    Therefore, instead of the hedge fund itself being taxed, the individual investors are taxed as part of their income tax. This avoids double taxation of the trustees. A company, on the other hand, is subject to both corporate and income tax.

    For all Australian business structures, you will need to apply for an Australian Business Number (ABN). You'll also require a registered business name and a tax file number (TFN).

    Which legal documents you need will depend on the specific hedge fund you decide to start. Some of the legal documents you may need include:

    • Compliance plan. A compliance plan document identifies the policies and procedures in place to ensure that the trust or company complies with national laws and regulations. You must appoint an official auditor who will conduct an audit and produce a compliance plan auditor's report.
    • Form 5111. A document that is submitted to ASIC at the end of every financial year. It's filed together with the compliance plan auditor's report.
    • Financial Report. An annual report regarding the financial health of your hedge fund, which is submitted to ASIC. The report includes a statement of profit and losses, statement of changes in equity and a director's report.
    • Investment agreement. A contract that's signed between a company and an investor. This agreement outlines how much is being invested and any conditions of the investment.
    • Shareholder agreement. A shareholder agreement acts as a contract between the company and its shareholders. This agreement is only required for registered companies and not a trust.

    Your hedge fund must comply with national laws and regulations. A lawyer can draft or review your documents or other aspects of establishing the fund.

    You can find investment lawyers at Lawpath. Simply sign up, request free quotes and choose your best fit.

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    4. Raise capital for the hedge fund

    Raising capital is one of the biggest challenges of starting a hedge fund. Although there's no minimum requirement for getting started, it's advised that you raise between $7 to $25 million before starting. If you want to be recognised by institutional investors, you'll need at least $130 million.

    There are different ways of raising capital for your hedge fund, including:

    • Friends and family
    • Colleagues
    • Hedge fund seeders
    • Institutional investors

    5. Set up a fee arrangement

    The typical fee arrangement in the hedge fund industry is the "two-and-twenty" structure. This means that clients are charged 2% of invested assets for an annual management fee. This fee is irrespective of the performance of the investments.

    On top of the 2% fee, an incentive fee of 20% of profits is charged. The incentive fee is typically paid if an agreed level of profits is achieved.

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    Frequently asked questions

    What is an example of a hedge fund?

    Founded in 1994, Platinum Asset Management is one of Australia's traditional hedge funds. Others are K2 Asset Management and Blue Sky.

    How much does a hedge fund manager make?

    The average income for fund managers in Australia is $134,881. However, hedge fund managers can make a lot more in bonuses.

    Can I start a hedge fund with my own money?

    You can invest your own money into your hedge fund. Many investors are known to only invest in hedge funds when the manager has money invested themselves. However, the startup costs involved with launching a hedge fund are very high. It's generally advised that a hedge fund raises a minimum of $7 million in seed capital before starting. To pay for the running costs and to attract other investors, hedge funds generally require a minimum of $100 million in seed capital.

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