Speaking to start-up hedge funds - what to look out for

[tol1]

Hi everyone,

 

I am speaking to start-up hedge funds (I am a fundamental equities investor) that I could potentially join as Partner and was wondering what the key questions are. So far, I have focused on LP composition, overall size and lock-up for LPs, discretion for me, profit share, investment strategy and work streams, and vision. Appreciate every comment or advice.

 

Thanks

 

[eclecticvalue]

Ask about how they judge their own performance, especially over what time frame?

 

 

If I don't mind asking where do you find start-up hedge funds?

[racemize]

#1 question for me is how much of their net worth is in the fund.  If it isn’t very high, they need a damn good reason.

[tol1]

Ask about how they judge their own performance, especially over what time frame?

 

 

If I don't mind asking where do you find start-up hedge funds?

 

It is a relatively small industry per strategy and people reach out.

[nickenumbers]

I think one must be very cautious when investing with an investment manager. They are interested in making money for themselves, you are interested in making money for yourself.  The incentive is not always aligned.

 

I guess I have a philosophical problem with it where I don't believe they will be able to earn you an above average return, net of fees, and risk adjusted over time.  Plus add in your time and interest to follow it, and loss of liquidity.

 

Why not just invest your capital yourself?

 

Ask about the fee structure.  I like the version that Mohnish Pabrai uses currently and Pabrai copied from WEB used once upon a time.

 

 

[tol1]

I think one must be very cautious when investing with an investment manager. They are interested in making money for themselves, you are interested in making money for yourself.  The incentive is not always aligned.

 

I guess I have a philosophical problem with it where I don't believe they will be able to earn you an above average return, net of fees, and risk adjusted over time.  Plus add in your time and interest to follow it, and loss of liquidity.

 

Why not just invest your capital yourself?

 

Ask about the fee structure.  I like the version that Mohnish Pabrai uses currently and Pabrai copied from WEB used once upon a time.

 

I think you may have misread my post. I am an investor myself and may join a start-up hedge fund.

[LC]

Roles and responsibilities

% of NW invested as racemize mentioned

Decision making process

I'd ask for records of the last 5 years to see each position and how profitable it was

 

Also I'd ask yourself what you are looking to gain from this? What do you get out of it?

[tol1]

Tx -

 

Anything regarding the structure of the fund itself? Is there certain red flags when it comes to discretion and or profit sharing?

[SharperDingaan]

Value proposition. You could continue doing what you're doing now, or be a HF partner. For this change of status what's your net benefit (short/medium/long term)?, your net cost (time + $)?, & are you getting paid enough for the additional risk? If you're the 'silent partner' with no say, you want the MAJORITY of annual net income paid to you - it's your money, & nobody makes anything unless you put it up.

 

$ invested. Is this a small amount of your total wealth, or a concentrated bet with most of it?  Ideally it should be large enough to keep you focused, but not enough to kill you - if it fails. Consider paying for  market research on the success of HF's, and treat the cost as due diligence.

 

SD

 

 

 

[BG2008]

I think the most important thing is qualitative and character related. I am assuming that you are considering joining a start up fund in a role of co-founder, partner #1-5, or as a primarily asset raiser.  In case these are correct assumptions, I would suggest that you try to figure out the following:

 

1) Who are you getting in bed with?  Is the guy/gal someone that you would let your wife and kid manage money with in case you got hit by a bus.  If the answer is absolutely yes, great.  If the answer is no or maybe, you're probably better off not going forward and I can save you a lot of time.  Keep in mind, there are two aspects to this. One is the your perception of the person's ability to compound capital on a risk adjusted basis over a long period.  The second part maybe more important, the person's character.  There are a lot of people who will pass the first test by a mile, but I will not partner with them due to the second part.  If they are the takers type in the classic taker, giver, and matcher examples, I would suggest that you back away.  A taker will try to take something from you at every opportunity.   

 

2) What is your role?  Will you be co-portfolio managers?  If yes, I would recommend you stop.  The track record of Co-Portfolio managers is terrible.  I guess it's because the fund eventually run into performance issues.  Then the finger pointing starts.  If you are the sole CIO, then you look in the mirror and you said, I screwed up, let's regroup and move on.  Investment by committee is usually a terrible idea.  This doesn't mean that you can't let your trusted friends smell test your ideas. I actually endorse smell test by your friends.  Typically roles where your function is vastly different than your partner tend to work better. For example, your partner does all the capital allocation and you bring the fund raising capabilities.  Those relationships tend to be healthier and enduring.  The only example of co-portfolio manager that seems to have endured and prospered is Scoggin Capital Management.

 

3) How will you guys pay bills?  What about the most basic research items like travel and subscriptions etc.  What is the AUM at launch date?  Do you have W-2 wages now?  Just understand that you maybe going from a stable paying job to something that is likely bootstrapping.  You generally need $10-20mm of AUM to kind of pay for expenses and pay yourself a living wage assuming you guys actually charge a management fee.  This is lesser of an issue if you guys have a good chunk of savings yourself.  I think if you are very passionate, this is lesser of an issue.  I think item 1) and 2) are deal breakers.  Item 3) is more along of the line of how willing am I to live below my means for an extended period of time. 

 

4) Follow the the advice others have mentioned.  Once you're past 3) I think you're good to follow the process and line of questions that a job seeker at a HF would consider.

[TBW]

Bg - that is excellent advice and some I wish I had thought more about when I was in a similar position as TOL.

 

Definitely learn delegation of duties, don't assume. What is process to close trades, investment discretion.

 

Make sure deal is fair, equity etc. and as BG said character is absolute most important. Trust your gut even if people you talk to speak highly.

[tol1]

Tx - all fair / relevant points, in particular regarding Co-PMs. At the ending of the day there is so many moving parts that can lead to one not accepting an offer. Hence, I may opt for starting my own fund at some point.

[Jurgis]

BG2008, great suggestions.

 

I hope tol1 does not mind if I OT a bit.

 

Keep in mind, there are two aspects to this. One is the your perception of the person's ability to compound capital on a risk adjusted basis over a long period.  The second part maybe more important, the person's character.  There are a lot of people who will pass the first test by a mile

 

I might be too picky or in wrong circles or whatever, but I don't know a single person "who will pass the first test by a mile". Well, maybe one person and even then I'm not sure. And this includes CoBF crowd - sorry guys...  ::)

Well, you said "compound" not "outperform", so perhaps I'm being too picky...

 

I guess tol1 has to be an optimist though if they plan to start/join a HF.  8)

 

So good luck!  8)