You want to start a hedge fund. You’ve got a clear plan on what kind of assets you want to invest in, and what investment strategy you will use for your fund. Then you find yourself wondering how on earth to set up that fund. In this article we will try to shine some light on which service providers you'll need.
In addition to the traders that you’ll employ and the fund managers overseeing the entire portfolio, you will have to appoint service providers to help your fund thrive.
Key Third-Party Service Providers
Fund administrators duties include handling NAV calculations of the fund, managing the investor subscription & redemption process, carrying out all necessary due diligence on the investors (KYC/AML) and preparing financials reports. It conducts trade and account processing, confirmation & reconciliation, cash management, shareholder register management, investor document retention and oversees investor communication.
Onshore and offshore legal counsel are retained by hedge funds to advise on legal matters, prepare contracts & agreements and review fund marketing material. They will also play a role in investor dispute resolution & litigation and assist with changes to the structure of the fund. In a coming article, we will outline the typical documents and procedures that are necessary for the formation of an offshore hedge fund.
Prime brokers serve as the fund’s gateway to the financial markets, by offering services such as execution & clearing, securities lending (shorting), and financing (leverage/margin trading). Additional services such as capital introduction, portfolio stress-testing, financial reporting, operational and risk consulting may also be offered by prime brokers. The fee structure for prime brokers tend to be different to other service providers. Fees are normally charged indirectly: Spreads on financing (by offering leverage and facilitating share borrowing for short sales), trading commissions charged for execution & clearing and fees for custody & clearing services. While startup hedge funds may initially start with a single prime broker, over time most hedge funds diversify and retain multiple prime brokers.
Custodians, which may be required by law, safeguard fund assets by providing custody services. Custodians offer the hedge fund & investors transparency over assets, and ensure an additional layer of operational scrutiny over the safety and security of assets. Some prime brokers have custody services as part of their offerings. However, large hedge funds may decide to use a custodian separate to their prime broker. Custodians may provide additional services, such as calculating NAV of a fund, monitor local sub-custodians where region-specific regulatory constraints require institutions to hold assets within a specific jurisdiction and cash management & FX services.
Third-party auditors work with the fund administrator and assess the valuation of the fund and verify the fund’s annual financial statements. In addition, they will review the fund’s valuation methodology and its implementation. In certain jurisdictions, consent letters from auditors are required as part of the regulatory process.
A bank account will be opened for the hedge fund’s management company, to pay for ongoing expenses (such as rent and salaries) and to receive management & performance fees. Additional bank accounts will be open for each fund, for receiving subscriptions from investors and for processing investor redemptions.
Other third-party service providers, which are not required but may be used by new hedge funds, are listed below.
Optional Third-Party Service Providers
An outside/part-time CFO may be hired to advise on finance-related matter, as startup funds may not want to retain a full-time CFO given budgetary constraints. CFOs work with the auditor and administrator to prepare financial statements, oversee cash flow, budgeting & financial planning requirements, manage third-party service providers and provide in-house tax and compliance-related advice.
Hedge Fund Consultants
A third-party hedge fund consultancy may be used to provide marketing services and investor relations. Functions include preparing investor documentation, responding to investor queries and designing marketing material.
Risk & Compliance
An outside compliance firm may be used to advise on compliance-related matters, draft internal AML/KYC policies, procedures and controls, develop appropriate employee training and review existing AML/KYC processes, examine risk-related procedures and methodologies used in the hedge fund.
Tax advisors may be retained alongside outside counsel to advise on the suitability of fund structures (in relation to the jurisdiction that the fund operates in and sells to), tax compliance matters and on individual tax-related cases.
Technology & Operations Consultants
Capital markets consulting firms may be used by startup hedge funds to set up both the physical and digital infrastructure for the hedge fund. Consultants may help integrate technology with data feed suppliers and other third-party software platforms, set up and manage document management solutions and design and maintain hedge fund’s public-facing & investor-facing website. SLAs (Service-level agreements) will be agreed with the consultancy.
Technology Vendors & Research Boutiques
Hedge funds may need to secure agreements with data providers, trading terminals (such as the Bloomberg Terminal), news platforms and research boutiques, to ensure that the hedge fund analysts are well equipped for their role.
Hedge funds may outsource the HR and recruitment functions to one or more HR specialists. The role of HR specialists range from sourcing new candidates and graduate recruitment to managing internal training programmes, liaising with the CFO and the Finance department for employee pensions and handling employee disputes.