The Basics of Hedge Funds

Hedge funds are pooled investments that involve aggressive trading strategies to generate very active returns for their investors. They've gained quite a big name because of these returns. But hedge funds aren't an option for the average investor, mainly because initial investment requirements are usually fairly high and can only be fulfilled by 澳洲幸运5官方开奖结果体彩网:accredited investors, such as institutional investors and 澳洲幸运5官方开奖结果体彩网:high-net-worth individuals (HNWIs).

Hedge funds are just like 澳洲幸运5官方开奖结果体彩网:mutual funds because both allow investors to purchase and sell shares. But because they involve aggressive investment strategies and veඣhicles, hedge funds come with more risk to the investor. Regulation of the hedge fund industry was fairly lax, but things changed after the financial crisis.

These funds a𓃲re a complicated beast, not only for investors but also for those who manage them. Establishing one comes with hurdles—many m🌠ore in the United Kingdom than in the United States. The process, which can take at least three months to complete, often leads many new firms to hire an external company to establish and ensure the fund is fully compliant with all laws and regulations.

Still interested in starting your own hedge fund? Keep reading to learn moꦓre about the basics of hedge funds and the steps you need to take to start your fund in the United Kingdom.

Regulations and Approvals

Hedge fund managers must get approval to start funds in the U.K. under the Financial Services and Markets Act 2000. The first and most fundamental step is learning how to navigate the governing body. Regulation and authorization approval falls under the , formerly known as the 澳洲幸运5官方开奖结果体彩网:Financial Services Authority (FSA).

Applications submitted to the Financial Conduct Authority can take up to six months to be approved. Part of the approval process requires the 澳洲幸运5官方开奖结果体彩网:investment manager to demonstrate adequate financial resourcesꦇ and appropriate staff, systems, and controls to manage t⛦he fund. There are several prerequisites:

• Establish financial resource requirements depending on whether the fund falls within the Mar𒁃kets in Financial Instruments Directive (MiFID) of the European Community.
• Prove investment staff competency by passing an exam in full or part based on experience in management outside the U.K.

Hedge funds may be monitored for up to a year after approval. This oversight includes rules related to the conduct of business, financial records and reporting, 澳洲幸运5官方开奖结果体彩网:compliance, and complaints. Fund marketing is governed by the Alternative Investment Fund Managers Directive (AIFMD). Investment managers must receive approval from the regulator in their established country in order to market funds in a European Union (EU) country.

Key Elements

Navigating the external regulations and authorizations is only one of the challenges hedge fund managers must conside🤪r. Before they begin operations, fund founders must also decide on the:

• Jurisdiction
• Structure
• Oversight and providers
• Components

Let's take a look at each factor and how they relate to the hedge fund industry in the United Kingdom.

Jurisdiction

This is the geographic location of the hedge fund's operations. The jurisdiction doesn't have to be in the same location as the fund's administrator. So why is it important? The fund's headquarters defines its tax structure or how it is taxed.

Many funds are based in 澳洲幸运5官方开奖结果体彩网:tax havens offshore. Countries like the Cayman Islands, Bermuda, Luxembourg, or Ireland are popular choices because they have very favorable corporate tax laws. For instance, the 澳洲幸运5官方开奖结果体彩网:Cayman Islands is one of the largest offshore financial centers in the world. Businesses set up in the region are not taxed.

Hedge funds benefit from offshore jurisdictions because it's the investor, not the fund, who is taxed on the fund portfolio's 澳洲幸运5官方开奖结果体彩网:appreciation.

Fund Structure

The structure of the fund is chosen based on the type of investors and their needs. This includes tax status, the ability to use leverage, and 澳洲幸运5官方开奖结果体彩网:voting rights.

The typical structures for hedge funds are:

• Stand-alone: This is a single fund in which several investors purchase shares.
• Segregated portfolio companies: These are separate legal entities where each investor has a separate fund account with their own assets and 澳洲幸运5官方开奖结果体彩网:liabilities.
• Master/feeder and umbrella funds: These funds fall in the middle of the two extremes listed above. Firms use this structure to satisfy different investor requirements, such as tax status or leverage restrictions. Feeder accounts feed into the master fund, which then trades on behalf of the 澳洲幸运5官方开奖结果体彩网:feeder funds.

Oversight and Providers

British law calls for 澳洲幸运5官方开奖结果体彩网:hedge funds to have at least two independent directors, who, for tax purposes, must be based offshore. The Investment Manager Exemption (IME) allows a hedge fund to appoint a U.K.-based investment manager if they meet certain criteria.

Many funds are set up as self-managed funds. In these cases, management teams represent the fund's appointed officers, saving both time and money. Other providers who want to start a hedge fund include administrators, independent auditors, custodians and/or prime brokers, legal counsels, and 澳洲幸运5官方开奖结果体彩网:tax advisors.

Regardless of how oversight and providers are set up, managers must act independently when they provide investment management services and all 澳洲幸运5官方开奖结果体彩网:transactions must be conducted in the ordinary course of business. Managers receive customary fees in return for their services. But they cannot comprise more than 20% of the fund’s assets.

Fund Components

Management needs to make certain decisions about the components of their fund bꦯefore it can be established. Here are the components that must be taken into consideration.

• Share classes: Many hedge funds create different 澳洲幸运5官方开奖结果体彩网:share classes, such as management and investment share classes. Management shares usually hold voting rights while investment shares are considered nonvoting. Separate share classes can also be established for any officers and employees of the investment manager, which allows them to avoid paying fees. There can also be a share class for U.K.-taxable investors.
• Fees: Hedge fund fees come in many different forms. But they have traditionally followed one simple structure. The 澳洲幸运5官方开奖结果体彩网:two and twenty fee structure pays a 2% management fee out of the 澳洲幸运5官方开奖结果体彩网:assets under management (AUM) and a 20% performance fee of the appreciation or hurdle rate exceed.

Withdrawal Restrictions

One of the biggest components that management must determine is how wit꧟hdrawals are treated and if there are any fees ꧑attached.

One of the most common provisions is called the 澳洲幸运5官方开奖结果体彩网:lock-up period. Investors aren't allowed to cash out their shares by selling or redeeming them during this time, usually one to two years. That's because the fund manager needs time give to rebalance their portfolio in certain circumstances.

Funds may charge fees if investors break the lock-up provision. They may also charge 澳洲幸运5官方开奖结果体彩网:redemption fees just like some mutual funds.

Special Considerations

Fund managers need to consider establishing a track record and proving they have what it takes to succeed. The length of a fund's track record depends on any special conditions potential investors have as well as the manager’s pedigree or experience. Investors generally like to see an apples-to-apples comparison by comparing the manager's track record from another firm with the same strategy.

Seed capital is also important, especially when it comes to regulatory requirements. It allows the fund to be set up with ease, ensuring that 澳洲幸运5官方开奖结果体彩网:operating costs do not negatively impact t♕he fund's performance. Having the right structure in place means that costs are external to and do not supplant the fu🍸nd's overall performance.

Marketing and Solicitation

As stated above, the AIFMD governs how hedge funds can market and solicit their assets. The AIFMD has explicit rules on how firms can market their funds and solicit assets.

As of 2018, U.K.-based hedge funds must adhere to the AIFMD. This wasn't always the case, though. Prior to 2018, these funds were able to simply adhere to 澳洲幸运5官方开奖结果体彩网:private placement rulesꦆ without the need to follow the AIFMDඣ as long they met the following criteria:

• They only marketed their offerings in the U.K.
• Marketed the fund outside the European Union
• Relied on reverse solicitation where the investor approaches the hedge fund and not the over way around

Managers who will solicit assets in the EU must comply with these rules to establish a marketing license.

The Bottom Line

Hedge funds in the U.K. are subject to more regulatory establishment criteria than funds in the United States. If you're looking to start your own fund, make sure you contact the proper governing bodies to ensure that you're in compliance with the stringent rules and regulations.

Depending on the complexity of your planned hedge fund firm, you may choose to hire an outside company to help you waꦜde through the process. Your understanding of and compliance with all requirements will help provide a strong backbone to the new hedge fund.