Starting a hedge fund as an investment banker

How do you start a hedge fund as an investment banker? The answer is complicated. While you may be well-placed to do this based on your career and experience, setting up a hedge fund is a long and sometimes arduous task – one which requires plenty of patience, skill and funding.

Having said that, perhaps the most important part of setting yourself up for success is to conduct thorough research to determine exactly what it takes to create a hedge fund. Here’s our ten-step guide to get you started.

1. Get approval from your local financial regulatory authority

Before you can set up your hedge fund business, you’ll need to get approval from the relevant authority(s) which governs financial conduct in your location. In most countries, hedge funds are highly regulated – for example, the Financial Conduct Authority (FCA) in the UK cracked down on hedge funds following the financial crisis of the late 2000s.

In the EU, the Alternative Investment Fund Managers Directive (AIFMD) was launched in 2011 to ensure hedge fund managers are transparent about their activities and follow strict regulatory rules. As an EU directive, AIFMD brought the UK’s alternative investment industry in line with EU law, but since Brexit, there has been some uncertainty over whether the UK will retain this legislation or adopt its own version.

2. Leverage your network

You may have built up a network during your employment at an investment bank – now is the time to use it. Contact friends and colleagues with investment experience in areas such as managed funds, venture capital or private equity, as they may be able to offer you valuable hedge fund advice.

3. Determine how you’ll raise your capital

Are you going to raise money via hedge fund seeders, endowments or your own savings? Perhaps a combination of all three?

To convince investors that your investment strategy is worth taking a punt on, you might consider hiring a marketing expert to help promote your business and strategy to your target market if this isn’t your forte.

4. Stay up to date with cybersecurity threats

Ensuring your cybersecurity is airtight is an important part of maintaining your reputation and remaining compliant with regulations.

The Hedge Fund Journal lists five 'digital crown jewels' which could be at threat of cyber-attacks and expose your company to reputational/headline risk, regulatory breaches, business damage, fund risks and/or loss of investor trust. These crown jewels are your: client data, proprietary algorithms/strategies, trading book, ongoing ability to execute trades and public website/client login.

5. Prepare for regulatory scrutiny

Hedge fund compliance is complex in any location, right down to the wording you use when describing or marketing your fund. For example, the FCA stated that managers who describe their funds as 'sustainable' should ensure the language is 'concise and accessible' for consumers. This goes hand in hand with stipulations that other disclosures aimed at institutional investors must be clear and detailed.

Hedge fund managers operating their businesses in the UK will also be subject to anti-money laundering regulations – specifically the Money Laundering Regulations Act 2017, which was updated in January 2020 to incorporate standards set by the Financial Action Task Force and the EU's 5th Anti-Money Laundering Directive.

In EU member states, hedge funds must be authorised by the competent authority of their home Member State. Managers can 'passport' their services throughout the union with just a single authorisation, and may be permitted to do so to non-EU AIFMs, subject to the conditions of the AIFMD (3).

6. Lay the legal groundwork

As you’ll be operating in a heavily regulated environment, there are numerous legal complexities to sort out, on top of taking care of your hedge fund risk management. There are platforms that facilitate fund, investor and service provider connections, one of which is Altallo, a partner of ours. You can find administrative, legal, trading, auditing and other services on this platform.

Depending on your jurisdiction, you may need to prepare a key information document if you're selling products to EU retail investors. Packaged retail and insurance-based investment products (PRIIPs) require investment managers to make these documents available to EU-based retail investors in good time before they invest.

7. Choose your location carefully

The jurisdiction where your hedge fund operates is important – you’ll need access to investment professionals, a good talent pool, an understanding of the local market and the relevant regulations.

8. Set up a great team

Ideally, you want a diverse team with experience in managing hedge funds. For example, if you were to hire a marketing manager, this person would preferably have significant experience in marketing investment products to institutional investors and establishing long-lasting business relationships.

9. Create a consistent and coherent strategy

Whether you create an ESG investment strategy, speculate on merger arbitrage or invest in equities and ETFs, your investors will want to see that you’re confident with the strategy you’ve chosen – and have a solid plan with data to back it up.

10. Partner with experts

Drive your business forward by partnering with a trusted prime broker – like IG Prime. We’re backed by advanced technology and offer exceptional execution, custody, liquidity and risk management services.
The complexities of opening a hedge fund as an investment banker are numerous, but as long as you conduct thorough research and put your financial services experience into practice, you have a good shot at making it successful.