Setting up an investment fund - need some advice

[tnp20]

Friend of mine and I are thinking of setting up an investment fund. We are considering a partnership model or LLC. Our goal is to run our own money for 2 years to establish an audited track record and then open the fund to outside money and charge a small fee for managing money though not the typical 2-20 hedge fund model....something lot less onerous. We are looking for absolute returns by exploiting special situations - rights offering, arbitrage plays etc.

 

For the first 5 years, our fund is expected to be less that $25M.

 

What is the best structure that we should look at to set up and how much can we expect it to cost both upfront and ongoing running costs. Looking for pros and cons of the different structures. Also looking for legal contacts to start discussions.

 

The fund will initially be seeded with $1M.

 

Thanks

 

Tom

[cmattporter]

I would read the Buffett Partnership letters. There's good structuring ideas. Also find a good accountant. Smaller single run accounting groups know how to set up a partnership, llc, etc. legally. If you can't find anyone ask a lawyer. They can help with future investor contracts. Let me know if this helps.

 

cmp

[Shawn]

To better answer your questions - are you in Canada or in the United States ?

[tnp20]

in USA.

 

 

[merkhet]

In my experience, your legal costs will run somewhere in the range of $20,000.

[writser]

In my experience, your legal costs will run somewhere in the range of $20,000.

 

Annually or startup fees?

[Hubris]

Well you have to consider which investors your targeting in the future. Since many of your ideas seem to be short term catalyst driven tax exempt investors will enjoy superior returns.

 

Small funds usually cost about $20,000 $40,000 to setup.

 

Consider fund admin and audit as well. Do you want small offices as support or medium sized enterprises ($2B+) for admin? Do you want second tier auditors BDO, Grant Thornton, etc. or one of the big four? It just depends how aggressive you are about raising capital in my opinion, the pricier options are brands which lend some credibility to your operation. (This is based on perspectives here in the Middle East, however I feel it might still apply in the states.)

 

The legal structure you choose will matter if your ever going to consider a master/feeder structure for onshore/offshore investors.

 

The most valuable advice I got was to add a pay in kind clause to the offering documents. Its just like how warren distributed the BRK shares to the original partners. If you ever think permanent capital might be more attractive than fees this is an issue you must think about.

[Guest deepValue]

Running your own money should be quite inexpensive. You have to pay filing fees for entity formation, but that's about it. Wait to get your record audited until you've put together a good track record and are ready to raise outside capital. Then continue administering the fund yourself to keep costs low until you earn enough of a management fee to justify hiring accountants, etc.

 

Edit: Oh, and plan on not making any money for the first five years; otherwise, you'll become myopic as soon as you get some outside capital on which to charge a performance fee.

[merkhet]

In my experience, your legal costs will run somewhere in the range of $20,000.

 

Annually or startup fees?

 

Start up

[JBird]

How is this thread not brimming with advice?

[Mephistopheles]

How is this thread not brimming with advice?

 

+1

[tnp20]

Thanks again for all the input from everyone.

 

Actually got a lot of useful information.

[Mephistopheles]

I actually have a question unrelated to the legal/cost aspect.

 

A friend and I are also pondering opening our own partnership. We do our own research, but once we open the fund, I think we'll be worried about trusting our own ideas initially. We are thinking that in the first few years we want to clone most of our investments, Pabrai style. Of course we would still reverse engineer and follow them like a hawk. But in the beginning we mainly want to buy stocks that Buffett, Berkowitz, Chou, etc. are in, to remain safe. Is this a sound strategy?

[constructive]

Mephistopheles,

 

I think there is not that much demand for the Pabrai approach. How many money managers besides him emphasize cloning other people's ideas?

 

For better or worse, one of the main things investors respond to is confidence. If you don't have a comfort level (yet) with your own analysis they will sense that.

[oddballstocks]

Mephistopheles,

 

I think there is not that much demand for the Pabrai approach. How many money managers besides him emphasize cloning other people's ideas?

 

For better or worse, one of the main things investors respond to is confidence. If you don't have a comfort level (yet) with your own analysis they will sense that.

 

Confidence is key, absolutely key.  Random story that is related to this:

 

I had a friend who needed a guitarist for a band, they performed every week to a decent sized audience.  I asked what he looked for and this is what he said "I want someone confident, I'd rather have someone who isn't that great and acts like they are verses someone who is insecure and reflects that." 

 

Granted there are caveats to everything, you need to have a proficient level of ability, but given two people with the same ability level the confident person will win out.

[JBird]

I actually have a question unrelated to the legal/cost aspect.

 

A friend and I are also pondering opening our own partnership. We do our own research, but once we open the fund, I think we'll be worried about trusting our own ideas initially. We are thinking that in the first few years we want to clone most of our investments, Pabrai style. Of course we would still reverse engineer and follow them like a hawk. But in the beginning we mainly want to buy stocks that Buffett, Berkowitz, Chou, etc. are in, to remain safe. Is this a sound strategy?

 

If you wanted to answer this question Munger-style I think you would turn it back onto yourself. Would you employ an investment manager who planned on using a clone philosophy because he lacked confidence in his own ideas? The idea of course is: don't sell something you wouldn't buy yourself.

[Mephistopheles]

Thanks for replies guys. Let me just say a few things. Firstly, I wouldn't tell my clients that I'm cloning, and def. not brag about it like Pabrai. Next, even though the term is "cloning", I'd still have all the research to back up the ideas, it wouldn't be plain cut and paste approach. It's not that I don't have confidence in my own ideas, as I'm doing well for myself. But for obvious reasons, I'd be far more okay losing my own money than someone else's. It's like, I personally am okay with investing all my money into 1 stock (and I have in the past), but I don't think I'd be comfortable doing that with client money.

 

My main point here was that I don't want to sell the idea of cloning to potential clients, but rather do it for our own sanity, and to ease in our personal ideas slowly, rather then all at once. What matters most is that we provide the clients with satisfactory risk adjusted returns, and for that I am certainly confident. It's just a matter of how to get there.

 

EDIT: Now that I think about it. Many ideas are cloned, aren't they? Like SHLD for example. Is it considered cloning of Berkowitz for everyone on this board who has invested?

[oddballstocks]

Thanks for replies guys. Let me just say a few things. Firstly, I wouldn't tell my clients that I'm cloning, and def. not brag about it like Pabrai. Next, even though the term is "cloning", I'd still have all the research to back up the ideas, it wouldn't be plain cut and paste approach. It's not that I don't have confidence in my own ideas, as I'm doing well for myself. But for obvious reasons, I'd be far more okay losing my own money than someone else's. It's like, I personally am okay with investing all my money into 1 stock (and I have in the past), but I don't think I'd be comfortable doing that with client money.

 

My main point here was that I don't want to sell the idea of cloning to potential clients, but rather do it for our own sanity, and to ease in our personal ideas slowly, rather then all at once. What matters most is that we provide the clients with satisfactory risk adjusted returns, and for that I am certainly confident. It's just a matter of how to get there.

 

EDIT: Now that I think about it. Many ideas are cloned, aren't they? Like SHLD for example. Is it considered cloning of Berkowitz for everyone on this board who has invested?

 

Cloning is perfectly acceptable in the hedge fund world, it's a way to scrape fees off institutional investors, they're called Fund of Funds.  You start a fund to invest in other funds, you take a fee, and the underlying fund gets a fee.  Managers make out and the investor is lucky to get the market return.  Yet the sales pitch is incredible.  You're offering the opportunity for some semi-large regional group to gain access to some super exclusive star investment manager that they could never access on their own.

 

 

[Kraven]

Thanks for replies guys. Let me just say a few things. Firstly, I wouldn't tell my clients that I'm cloning, and def. not brag about it like Pabrai. Next, even though the term is "cloning", I'd still have all the research to back up the ideas, it wouldn't be plain cut and paste approach. It's not that I don't have confidence in my own ideas, as I'm doing well for myself. But for obvious reasons, I'd be far more okay losing my own money than someone else's. It's like, I personally am okay with investing all my money into 1 stock (and I have in the past), but I don't think I'd be comfortable doing that with client money.

 

My main point here was that I don't want to sell the idea of cloning to potential clients, but rather do it for our own sanity, and to ease in our personal ideas slowly, rather then all at once. What matters most is that we provide the clients with satisfactory risk adjusted returns, and for that I am certainly confident. It's just a matter of how to get there.

 

EDIT: Now that I think about it. Many ideas are cloned, aren't they? Like SHLD for example. Is it considered cloning of Berkowitz for everyone on this board who has invested?

 

I get the impression that you are confusing actual "cloning" with idea sourcing.  That is, copying what someone else does vs using what others do as a source for potential ideas.  Why in the world would anyone want to pay someone else to clone?  Why not just go to the original?  I can't speak for anyone else, but for those who have invested in SHLD it would NOT be cloning Berkowitz unless they bought just because he did.  You're talking about investing in things because others have, but confirming the data.  There is a big difference between doing that and simply saying here is a list of 50 ideas that have been obtained from various sources. 

 

You have backtracked a little bit on your level of confidence.  That's fine.  You are clearly young and confidence comes with experience.  For your own sanity and preservation, I believe you should not invest anyone else's money until you truly feel confident that any investment you make is a good one and not just because Pabrai or Berkowitz has made it.  If you have doubts, then it won't be a pleasant time for you.  Managing money is stressful enough.  Add in a lack of confidence and the stress could be unbearable.

[merkhet]

Thanks for replies guys. Let me just say a few things. Firstly, I wouldn't tell my clients that I'm cloning, and def. not brag about it like Pabrai. Next, even though the term is "cloning", I'd still have all the research to back up the ideas, it wouldn't be plain cut and paste approach. It's not that I don't have confidence in my own ideas, as I'm doing well for myself. But for obvious reasons, I'd be far more okay losing my own money than someone else's. It's like, I personally am okay with investing all my money into 1 stock (and I have in the past), but I don't think I'd be comfortable doing that with client money.

 

My main point here was that I don't want to sell the idea of cloning to potential clients, but rather do it for our own sanity, and to ease in our personal ideas slowly, rather then all at once. What matters most is that we provide the clients with satisfactory risk adjusted returns, and for that I am certainly confident. It's just a matter of how to get there.

 

EDIT: Now that I think about it. Many ideas are cloned, aren't they? Like SHLD for example. Is it considered cloning of Berkowitz for everyone on this board who has invested?

 

I get the impression that you are confusing actual "cloning" with idea sourcing.  That is, copying what someone else does vs using what others do as a source for potential ideas.  Why in the world would anyone want to pay someone else to clone?  Why not just go to the original?  I can't speak for anyone else, but for those who have invested in SHLD it would NOT be cloning Berkowitz unless they bought just because he did.  You're talking about investing in things because others have, but confirming the data.  There is a big difference between doing that and simply saying here is a list of 50 ideas that have been obtained from various sources. 

 

You have backtracked a little bit on your level of confidence.  That's fine.  You are clearly young and confidence comes with experience.  For your own sanity and preservation, I believe you should not invest anyone else's money until you truly feel confident that any investment you make is a good one and not just because Pabrai or Berkowitz has made it.  If you have doubts, then it won't be a pleasant time for you.  Managing money is stressful enough.  Add in a lack of confidence and the stress could be unbearable.

 

+1

 

This was exactly what I was going to say.

 

Mr. Buffett & Mr. Munger say there are no points for difficulty. I would add that there are no points for originality in sourcing. Even Mr. Buffett has "cloned" before -- think about what he did with Jay Pritzker and the cocoa beans.

[Guest longinvestor]

Thanks for replies guys. Let me just say a few things. Firstly, I wouldn't tell my clients that I'm cloning, and def. not brag about it like Pabrai. Next, even though the term is "cloning", I'd still have all the research to back up the ideas, it wouldn't be plain cut and paste approach. It's not that I don't have confidence in my own ideas, as I'm doing well for myself. But for obvious reasons, I'd be far more okay losing my own money than someone else's. It's like, I personally am okay with investing all my money into 1 stock (and I have in the past), but I don't think I'd be comfortable doing that with client money.

 

My main point here was that I don't want to sell the idea of cloning to potential clients, but rather do it for our own sanity, and to ease in our personal ideas slowly, rather then all at once. What matters most is that we provide the clients with satisfactory risk adjusted returns, and for that I am certainly confident. It's just a matter of how to get there.

 

EDIT: Now that I think about it. Many ideas are cloned, aren't they? Like SHLD for example. Is it considered cloning of Berkowitz for everyone on this board who has invested?

 

Cloning is perfectly acceptable in the hedge fund world, it's a way to scrape fees off institutional investors, they're called Fund of Funds.  You start a fund to invest in other funds, you take a fee, and the underlying fund gets a fee.  Managers make out and the investor is lucky to get the market return.  Yet the sales pitch is incredible.  You're offering the opportunity for some semi-large regional group to gain access to some super exclusive star investment manager that they could never access on their own.

 

Don't know if you all saw it, but at the BRK annual meeting this year, Warren showed a slide on how the "Fund of (Hedge )Funds" has done versus the S&P Index five years since his bet.

 

S&P Index: +9.5% FoF: 0.5%

 

That fact won't get coverage in the mainstream, financial media

[crastogi]

Mephistopheles,

 

I think there is not that much demand for the Pabrai approach. How many money managers besides him emphasize cloning other people's ideas?

 

For better or worse, one of the main things investors respond to is confidence. If you don't have a comfort level (yet) with your own analysis they will sense that.

 

Confidence is key, absolutely key.  Random story that is related to this:

 

I had a friend who needed a guitarist for a band, they performed every week to a decent sized audience.  I asked what he looked for and this is what he said "I want someone confident, I'd rather have someone who isn't that great and acts like they are verses someone who is insecure and reflects that." 

 

Granted there are caveats to everything, you need to have a proficient level of ability, but given two people with the same ability level the confident person will win out.

 

I have been investing for the last 15 years using concentrated value philosophy.  A lot of my friends/family know I do fairly well, and often ask me for ideas.  Usually many stocks I own/have owned have a lot of hair around them.  So, most who ask either do not buy the recommendation, or will bail at the worst possible time (when they should be adding).  Many of the folks asking for recommendations are very smart, but this happens almost inevitably. 

 

My feeling is unless you do enough research to "own" an idea, it will be very hard to hold if the stock heads south temporarily, as most do.  For this reason, "cloning" sounds a lot better in theory than application

[oddballstocks]

Thanks for replies guys. Let me just say a few things. Firstly, I wouldn't tell my clients that I'm cloning, and def. not brag about it like Pabrai. Next, even though the term is "cloning", I'd still have all the research to back up the ideas, it wouldn't be plain cut and paste approach. It's not that I don't have confidence in my own ideas, as I'm doing well for myself. But for obvious reasons, I'd be far more okay losing my own money than someone else's. It's like, I personally am okay with investing all my money into 1 stock (and I have in the past), but I don't think I'd be comfortable doing that with client money.

 

My main point here was that I don't want to sell the idea of cloning to potential clients, but rather do it for our own sanity, and to ease in our personal ideas slowly, rather then all at once. What matters most is that we provide the clients with satisfactory risk adjusted returns, and for that I am certainly confident. It's just a matter of how to get there.

 

EDIT: Now that I think about it. Many ideas are cloned, aren't they? Like SHLD for example. Is it considered cloning of Berkowitz for everyone on this board who has invested?

 

Cloning is perfectly acceptable in the hedge fund world, it's a way to scrape fees off institutional investors, they're called Fund of Funds.  You start a fund to invest in other funds, you take a fee, and the underlying fund gets a fee.  Managers make out and the investor is lucky to get the market return.  Yet the sales pitch is incredible.  You're offering the opportunity for some semi-large regional group to gain access to some super exclusive star investment manager that they could never access on their own.

 

Don't know if you all saw it, but at the BRK annual meeting this year, Warren showed a slide on how the "Fund of (Hedge )Funds" has done versus the S&P Index five years since his bet.

 

S&P Index: +9.5% FoF: 0.5%

 

That fact won't get coverage in the mainstream, financial media

 

Doesn't surprise me at all, they always seemed to be the worst investments possible.  You have a fund with a high fee structure, and then a feeder fund with a high fee structure.  They're almost built so it's impossible for investors to actually do well, yet management does very well (the goal presumably).

[Philip Morris IV]

I think much of that has to do with the fact that generally, only the lower-quality funds accept FOF money.  Like most of the industry, FOF money is fickle and short term.  An excellent value manager will know this, and not wager the integrity of their fund on the high chances the FOF manager decides to redeem after a "bad" quarter.

 

 

I run a small registered investment adviser just for separate accounts, and would like to start an LP fund when my Masters is complete in a year or so.  My compliance guy doesn't do funds but would update my Form ADV.  Since I'm already registered, I imagine the first steps are LP setup (easy), then having a law firm draft the PPM, LPA and other offering docs, and then figuring out admin procedures, CPA audit and prime brokerage.  The $20k quotes seem high - what is the breakdown there?  Is most of that for the offering docs?  I probably spent about $5k all-in to get the RIA up and running.

[Mephistopheles]

Thanks for replies guys. Let me just say a few things. Firstly, I wouldn't tell my clients that I'm cloning, and def. not brag about it like Pabrai. Next, even though the term is "cloning", I'd still have all the research to back up the ideas, it wouldn't be plain cut and paste approach. It's not that I don't have confidence in my own ideas, as I'm doing well for myself. But for obvious reasons, I'd be far more okay losing my own money than someone else's. It's like, I personally am okay with investing all my money into 1 stock (and I have in the past), but I don't think I'd be comfortable doing that with client money.

 

My main point here was that I don't want to sell the idea of cloning to potential clients, but rather do it for our own sanity, and to ease in our personal ideas slowly, rather then all at once. What matters most is that we provide the clients with satisfactory risk adjusted returns, and for that I am certainly confident. It's just a matter of how to get there.

 

EDIT: Now that I think about it. Many ideas are cloned, aren't they? Like SHLD for example. Is it considered cloning of Berkowitz for everyone on this board who has invested?

 

I get the impression that you are confusing actual "cloning" with idea sourcing.  That is, copying what someone else does vs using what others do as a source for potential ideas.  Why in the world would anyone want to pay someone else to clone?  Why not just go to the original?  I can't speak for anyone else, but for those who have invested in SHLD it would NOT be cloning Berkowitz unless they bought just because he did.  You're talking about investing in things because others have, but confirming the data.  There is a big difference between doing that and simply saying here is a list of 50 ideas that have been obtained from various sources. 

 

You have backtracked a little bit on your level of confidence.  That's fine.  You are clearly young and confidence comes with experience.  For your own sanity and preservation, I believe you should not invest anyone else's money until you truly feel confident that any investment you make is a good one and not just because Pabrai or Berkowitz has made it.  If you have doubts, then it won't be a pleasant time for you.  Managing money is stressful enough.  Add in a lack of confidence and the stress could be unbearable.

 

I know it's been a month, but I realized I never replied, so I will now. You're right in that I confused cloning with idea sourcing. I certainly fit into the latter category of the two. While I never invest in anything just because a famous investor has bought in, I often look at their 13-F's for ideas. And while I am very confident that I can provide value for my clients, you are right in that I should be 100% confident in making investments for others in which no big investor is involved. I want to build more confidence over time, especially by learning more and more from this board. Hopefully at some point in the future I will be able to manage money for others with a lot more confidence. Thanks for your advice!