TL;DR
- A clear purpose or mission plays a critical role in determining hedge fund success
- Hedge Fund founders must understand why they are launching their own fund, define success, and establish guiding principles for the firm to follow.
- There are two common paths to launching a hedge fund, and understanding how why one launches a hedge fund plays a role in each.
- Finding purpose in what you do is the true differentiator for success in the hedge fund industry.
- While anyone can use formulas, resources, and ingredients to improve their chances of successfully launching and growing a hedge fund, the truth and authenticity of a founder’s vision and beliefs, which clearly define the firm’s purpose and are implemented through its culture, are the only true indicators of success.
Hedge fund managers’ paths to success have taken some detours over the last decade, but their importance in our economy continues to grow. Hedge funds have emerged as key players in industry consolidations, company breakouts, restructurings, and technological innovations, as they provide liquidity to markets while also innovating and taking risks. They have been rewarded for such significance, as evidenced by their ongoing ability to raise assets, albeit never easily. As a result, one might anticipate that raising capital for hedge funds will be simple. And it is usually simple for hedge funds that have been guided from the start by a clearly defined mission. Unfortunately, a growing number of hedge funds are entering the market for the first time completely misguided.
As with any other business, there are formulas, components, and resources available to everyone that can be used to enhance the likelihood of launching and growing a hedge fund. However, one key differentiator that not all other businesses must contend with is why the founder would set out on their own, how they define success, and the guiding principles they’d establish for the firm to follow. These are the elements that must be properly communicated both internally and externally throughout the implementation of a complex and ever-changing culture.
The true determinant of the success of a newly launched hedge fund is whether the founder has discovered and established a true purpose – a purpose that is unique to every successful fund. A hedge fund’s purpose or mission – the reason why it exists – is the actual answer to the enduring question, “what is your edge?”. This Insight examines the significance of revealing the “why” through the lens of two fictional, yet common, journeys traders take on their way to joining the billion-dollar club. If you’re a trader considering a launch or an emerging manager looking to refocus, this article will help you determine your next move.
Hedge Funds Are Like Traditional Businesses
Unlike traditional consumer packaged goods (CPG) businesses, where the product is often a clear byproduct of the company’s mission, the reason for the existence of a hedge fund is more abstract and, in many cases, non-existent. On the other hand, a hedge fund is similar to any other business in that it sells its product, an investment strategy, to a target market of investors and competes for attention and allocations with other alternative investment opportunities. While the makeup of the product varies (investment vehicles and processes, marketing collaterals, service providers, team backgrounds, etc.), the goal of every hedge fund remains the same: to perform and raise capital. Although the road to launch is frequently fraught with speed bumps, numerous pitfalls, and failures, many traders, portfolio managers, and analysts continue down this path. Unfortunately, many of them do so without ever understanding why.
Trader’s Perception vs. Reality
A clear purpose, a definition of success, and a defined culture that is ever-evolving to reflect the behavior of senior management are frequently missing pieces when launching a new venture. Consider the fictional yet familiar example of a trader at a large hedge fund who leaves to start their own business. The trader may formally resign or get stopped out of their risk limits, and they frequently rush to raise capital for a brand new fund. While this may appear to be an acceptable idea and a natural next step, the trader may likely proceed with erroneous ideologies rather than taking the time to understand why they are taking this path. Their ego can cloud their vision, and they may embark on their journey reciting the following false narratives:
- At heart, I am an entrepreneur.
- I’m confident in my strategy.
- I built the business at my previous (large) employer.
- I am unique in that I will concentrate on performance during the first year and then be off to the races.
When the more accurate reasons why a trader ends up down this path are more likely to resemble:
- I can’t find a job that pays as much as this one, so my only option, if I want to save face, is to start my own fund.
- My discretionary bonus is lower than expected.
- I was cut on my stop losses, but my risk limits were too tight.
- I have discovered the Holy Grail and do not wish to share it with my current employer. I’ll do it on my own and reap the benefits.
- I am confident that I am better compared to my current firm’s CIO.
What Should Traders Be Focused On?
Traders frequently underestimate the time and effort required to launch a hedge fund. They believe that because they witnessed or contributed to the growth of their previous firm, it will be simple to replicate. This underestimation of the value and resources provided by a large firm can result in a quick and painful end. To avoid this blunder, traders must ask themselves the difficult questions:
- Why do I want to venture on my own?
- Why does being on my own make sense now?
- Why and what do I want to achieve in the long term?
- Why and how will I accomplish it?
- Why and what will my firm’s culture be?
- Why do I think this will allow me to control my destiny?
The answer to “why” inherently includes a clear definition of success. So, what does success look like for a hedge fund? It’s not difficult to see why everyone’s definition of success differs. In general, when it comes to our own lives, the goal is to be happy, but this is also defined differently by most people. Fortunately, for hedge fund managers, success is more clearly defined by measurable metrics such as assets under management, performance, annual revenues, time in the business, reputation, or a combination of these factors. Although the metrics might be similar, the absolute numbers that determine success will vary from one manager to another. For example, one manager’s definition of success may be managing $300 million with a team of four and returning an annualized 50% net return, whereas another manager’s definition of success may be managing $10 billion with a 100-person team overseeing 20 different products.
While there is no right or wrong answer, everyone should agree that before launching a fund, success must be defined, at least conceptually. Success provides immediate direction, and while it may change, understanding where the organization is heading is critical, especially in its early days.
The Two Pathways
Many traders who decide to go it alone and start a hedge fund do so with the goal of joining the Billion Dollar Club. Although there are many ways to join this exclusive club, two appear to be more common than others. Fortunately, regardless of the path a prospective fund launcher takes, the most important determinant of their success and membership in the club will be understanding their “why” and carrying out a mission.
The following describes two of the most common pathways and how the “why” factor plays a role in each.
Path A: Two Pals and a Bloomberg
Allow us to introduce Adam, a successful trader with enough capital (a few million dollars) to make a living solely from trading. If Adam so desired, he could bring on a partner to invest and assist with non-investment-related issues, and together they could attract money from friends and family. However, Adam believes that the business can be run at a low cost and that he would like to limit the operational and legal burdens that come with regulatory registrations, so he decides to go it alone. Adam realizes early on why he wants to start a hedge fund: to pursue his passion for investing money in the market and making money while doing so without being at the mercy of any decision-maker who can withdraw their allocation at any time.
After a few years, if Adam was successful, he could attract limited partners who shared his vision and would invest with him in a trusting environment. This collaboration would increase Adam’s fiduciary responsibility, causing him to care as much about his investor’s success as he does about his own. This new perspective would lay the groundwork for a long-lasting business. With time, effort, performance, and a little luck, Adam and his new team may be able to join the billion-dollar club.
In this example, the path to success is fraught with unexpected traps and pitfalls, but Adam’s dedication to his long-term vision never wavered. He wasn’t looking for a quick buck; he was invested in the long haul. Adam will eventually attract like-minded institutional investors who will stick by him through good and bad times. Adam understood why he chose this path and stayed true to his passions and mission in all aspects of the business.
Path B: The “Perfect Recipe”
On this path, we encounter Barbara. Unlike Adam, Barbara attended an Ivy League school, began her career at a distinguished investment bank, and subsequently worked as an analyst at a prominent hedge fund. Later on, she became a portfolio manager at a blue-chip hedge fund, where she interacted directly with some of the world’s largest and most prominent investors.
Up until this point, Barbara has had a successful career, amassed a significant amount of wealth, and is now ready to embark on her own venture. Barbara is not just a portfolio manager; she has evolved into a leader who has earned the utmost respect and trust of her team over time. Barbara has fostered this trust through her selflessness and her ability to manage anxiety for both herself and her constituents during good and bad years.
Now, Barbara is ready to invest a significant amount of capital into both her management company and her new fund, totaling several million dollars. She also puts together a team of 5-15 accomplished individuals, both investment and non-investment, with whom she has previously worked with through different cycles. Barbara’s hedge fund business is institutional right from the start, attracting hundreds of millions of dollars in capital. Up till here, this story tends to be a common one. In fact, Mala Gaonkar, Founder of SurgoCap Partners, credits the availability of her own funds with giving her the space she needed to build the culture and team of her new fund. “My number one focus, and obviously, the benefit of having some personal capital to invest in this, was to say, ‘Okay great, let’s focus on finding a CFO and COO who could build out the operations to build an institutional platform,” Mala told Institutional Investor.
Yet, while this is a successful launch, predicting Barbara’s long-term success on this alone is impossible. Barbara has all of the key ingredients on hand, but her success in the investment industry depends on various factors, including talent, pedigree, investment process, risk management, market conditions, marketing, sales, infrastructure, and “luck”. Therefore, when discussing her business and fund with investors, instead of focusing on the benefits of the investment strategy, Barbara shares the story of what drove her to venture out on her own and why her firm exists. Her “why” becomes the backbone of the firm’s mission statement, which tells a differentiating story that is not based solely on performance. Herself, the firm’s mission, and its brand become its selling points. Of course, the investment strategy will always be the product that is bought, but the story is what will keep Barbara’s prospects remembering her.
Barbara is not alone in her approach; some of the world’s largest hedge funds have spent countless hours crafting mission statements that are used not only to sell the firm and the fund but also to drive the firm’s culture. Here are a couple of examples:
Bridgewater’s competitive edge is our pioneering workplace culture that relies on truthful and transparent communication to ensure the best ideas win out. We believe meaningful work and meaningful relationships emerge when you assemble high-performing teams and push them to engage in rigorous and thoughtful inquiry.
We champion diversity because it is essential to our ability to think differently. We cultivate inclusion because we believe people do their best work when they can be their genuine selves. By continually examining abilities and performance, we provide all our employees with the development they need to fulfill their potential as professionals and people.
Renaissance Technologies is an investment management firm that employs mathematical and statistical methods in the design and execution of its investment programs.
Our ambition is to be the most successful investment firm of all time. We strive to identify the highest and best uses of capital to generate superior long-term returns for the world’s preeminent public and private institutions.
As the Chief Investment Officer working towards fulfilling her mission, Barbara surrounds herself with people she trusts and to whom she can delegate investment and non-investment activities. By establishing guiding principles and promoting a culture that reflects upper management, Barbara can accomplish this with proper compensation.
While the “Perfect Recipe” for a successful hedge fund launch seems to pop up daily in a blog post or LinkedIn update, tried and true enduring recipes are scarce. The truth and authenticity of a founder’s vision and beliefs that clearly define the purpose of the firm and are implemented through its culture are the only true indicators of success. Stakeholders in the business will always strongly identify to the founders if they remain consistent in their vision and the established culture. If the strategy works as planned, it will validate the mission, bolstering the commitment of partners, employees, and investors.
Conclusion
Hedge fund founders, like any other business owner, must consider a variety of factors before committing fully. To find and articulate the reason why their hedge fund exists, founders should speak with insiders, educate themselves, and create multiple business plans. They must set goals for themselves and effectively communicate them throughout their four organizations by establishing a culture that reflects their long-term beliefs and goals. Whether the launch is bootstrapped or a day-one institution, the founder’s why will be the point of differentiation – the fund’s competitive advantage.
Hedge funds, as the saying goes, are bought rather than sold. Investors buy into managers who they believe can become long-term, trusted partners. Of course, the ideas and makeup of a manager’s specific investment strategy count for something but in good and bad times, investors rely on the actual human beings behind the pitch deck. Investors expect their manager to be a go-to resource in their field, someone from whom they can learn, and, of course, someone who can manage drawdowns. While anyone can use formulas, resources, and ingredients to improve their chances of successfully launching and growing a hedge fund, the true differentiator is finding purpose in what they are doing.
If you have read this article and believe you have an answer to why you should launch a hedge fund today, please reach out. We would enjoy the opportunity to discuss how you can best improve your chances of success.
About the Author
David Modiano is a Managing Director of Capital Strategies at Thalēs. David was most recently a Partner and Head of Business Development at Mill Hill Capital, a New York-based credit hedge fund founded in 2016. Prior to that, David spent ten years as second in command of the seeding team at Investcorp and Lyxor Asset Management, sourcing, seeding, onboarding, and growing early-stage hedge funds. As a senior investment professional, David personally reviewed, met with, and performed in-depth due diligence on nearly 1,500 hedge fund managers and negotiated and closed 16 hedge fund seed deals
The views expressed above are not necessarily the views of Thalēs Trading Solutions or any of its affiliates (collectively, “Thalēs”). The information presented above is only for informational and educational purposes and is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. Additionally, the above information is not intended to provide, and should not be relied upon for investment, accounting, legal or tax advice. Thalēs makes no representations, express or implied, regarding the accuracy or completeness of this information, and the reader accepts all risks in relying on the above information for any purpose whatsoever.
