What should I know before starting a Hedge Fund?
I want to start a quantitative fund where decisions are made through data science and operations research methods. What I really want to know are about things that only the ones in the industry (or have been) would know - clients, legal requirements, managing personnel, etc...
Some Context:
I don't think I'm one of those clueless kids who have an unrealistic dream of creating the next DE Shaw or Two Sigma. My fund would likely be trying to go for 10~30% each year. I'll mostly likely be hiring various engineers, data science, and operations research professionals + business and banking types for client mgmt and various other functions.
But, what I am is a "kid"; Fresh out of college, on my first job quantitative enough to help me get into a top PhD program. Realistically, I'll be working in the HF industry for a couple years to see how the sausage is really made.
So what that means is that, it'll take 7-10 years before I actually start a fund.
I already developed a method for one of my strategies that seems to be working well and will test out with my own portfolio for the next few years.
Would love to learn about what I'm really getting into.
You need to get capital. Without that it doesn't matter how good your strategy is. This is the hard part. beyond that, there are consultants that will handle compliance (SEC registration? State registration?), lawyers that will handle formation, administrators that will handle the payouts. This is the easy part.
Without a route to capital, like a personal/professional network, you will have a tough road. Good luck.
You say you're not looking to create the next DE Shaw or Two Sigma, but they return 10%-30%. However, I think quants miss how important sales/client relations are. Every fund goes through a period of sluggish returns, and you overcome this with excellent client relations.
As others have alluded to here, raising capital is hard. Very very hard. There are plenty of people out there with pedigree and claimed track records who struggle to raise capital, and end up joining a family office, forming their own, or much more often, going to an MM.
Investors now not only want risk-adjusted returns (ala Millennium etc) but also want robust back office processes and compliance especially post-Madoff. All of that costs a lot of money and resources (ie. people) that most start-ups don't have/can't afford. As a result of general lackluster performance from HFs over the last decade, many investors are also not as willing to pay the standard 2/20, at least not on day 1. One may be able to raise capital from fund of funds, private banks, HNWIs, family offices etc, who can be more flexible and far less demanding re the back office/compliance etc. But these investors can be flaky and the capital could be redeemed tomorrow.
The prized investors are the pensions, endowments etc. and they will usually demand a lot of resources to satisfy. Think about it from the perspective of some guy sitting at a pension. He is making $150k-$300k (latter if senior) and works nice hours. Job is pretty recession resistant, he's not a risk taker, and has a good work/life balance. Why on Earth would he stick out his neck and choose an unproven start-up fund and take that career risk when he could just chose a Millennium/Citadel etc. What's the upside for him? We know what the downside is, and that is the start-up doesn't do well, has numerous other risks and the fund could blow up. And he loses his job. OR he can go with the safe big choice that everyone else is in and if they do badly, well everyone else is facing the same issue right? Dude keeps his job.
This means that the big HFs who have done ok/well, made some money and have kept investors and have all of the infrastructure in place will continue to get bigger. That means that (with some exceptions) that start-up funds will often struggle to raise capital or will usually have a longer gestation period in which they will need to prove themselves in order to raise a meaningful amount of capital and that it will be a slog.
Having sat in an allocator seat in a previous life and with many friends still in the space, it's amazing to see how many choices of funds there are to choose from. And how few are actually any good for a sustained period of time (yes the definition of "good" can vary, amongst other things - but let's keep it simple).
High priced products (regardless of industry) need to deliver. Hedge funds are high priced products and many have not. This is not to be discouraging but just a heads up to understand how challenging it may be to raise a fund and scale it.
Good Luck