How to Start a Hedge Fund in the US

8/6/2019 How to Start a Hedge Fund in the US

1/24


2/24


3/24H F M W E E K . C O M 3

REPORT EDITORAnnie Roberts T: +44 (0)20 7029 4061 [email protected] EDITOR

Gwyn Roberts T: +44 (0)20 7029 4057 [email protected] PRODUCTION EDITORClaudia

Honerjager SUB-EDITORRachel Kurzfield DESIGNERMatt McLean OPERATIONS DIRECTORSebastian

Timpson CHIEF EXECUTIVECharlie KerrCOMMERCIAL MANAGERLucy Guest T: +44 (0)20 7029 4052 l.guest@

hfmweek.comPUBLISHING ACCOUNT MANAGERRichard Mason T: +44 (0)20 7029 4054 r.mason@hfmweek.

com PUBLISHING ACCOUNT MANAGERMatthew Rudd T: +44 (0)20 7029 4053 [email protected]

SUBSCRIPTIONS Raheem Salami T: +44 (0)207 029 4056 [email protected] CIRCULATION MANAGER

Fay Muddle T: +44 (0)20 7029 4084 [email protected]

HFMWeek is published weekly by Pageant Media Ltd, a certified member of the PPA

ISSN 1748-5894 Printed by Wyndeham Grange

2011 all rights reserved. No par t of this publication may be reproduced or used

without the prior permission from the publisher

Published by Pageant Media Ltd

LONDON

Suite L, 1 East Poultry Avenue EC1A 9PT

T+44 (0)20 7029 4000

NEW YORK

1375 Broadway, 11th Floor, NY 10018

T+1 (646) 278 9961

HFMHEDGEFUNDMANAGER

WEEK

he hedge fund sector evolves quickly. Fortunatelyso do its service providers. Since 2008s marketmeltdown, increasingly high calibre teams ofadministrators, lawyers, prime brokers and auditorshave emerged to solve the day-to-day demands ofmanagers, investors and regulators.

The successful launch of a new fund, whether it isdomestic or offshore, or indeed both, is dependent

on selecting the appropriate structure and complyingwith ever-changing federal and state regulations. A manager will need more layers ofsupport if a launch, or running an existing business, is to be successful.

The sectors service providers consistently excel at this. Increased regulatoryrestrictions, and nervous investors, are making fund launches more diff icult. Theheavy push on independent administrators, seen in the wake of the Madoff scandal,is also likely to continue. While administrators, prime brokers and legal counsel willall share the burden of implementing regulatory requirements proposed by DoddFrank and Basel III.

The year ahead will be a challenging time for first time f und managers lookingto launch under pressurised market conditions. Actively engaging in understanding

what the best practices are in managing and running the operations of hedge funds,and keeping abreast of industr y regulations will secure the greatest possible futurefor funds. Recruiting the right service provider remains essential to this process.

Annie RobertsREPORT EDITOR

T

H O W T O S T A R T A H E D G E F U N D I N T H E U S 2 0 1 1


4/24


5/24

FINANCIAL SERVICES

A top-ranked

legal advisor to theinvesting world.

For more information, please contact:

Robert W. Helm

+1 202 261 3356

[email protected]

Richard Horowitz

+1 212 698 3525

[email protected]

George J. Mazin

+1 212 698 3570

[email protected]

Kevin P. Scanlan

+1 212 649 8716

[email protected]

M. Holland West

+1 212 698 3527

[email protected]

With approximately 140 financial services lawyers in

the United States, Europe and Asia, our top-ranked

team has the reach, resources and experience to provide

comprehensive, cross-border services to the worlds

largest hedge fund and emerging fund managers.

Dechert has hedge fund work down to a fine art

Chambers UK

A powerhouse hedge funds practice

The American Lawyer

This firm has a peerless global footprint in the hedge

funds space

Chambers Global

Dechert is for many the first port of call for hedge fund

advice

The Legal 500 (UK)

One of the top three onshore legal advisors globally serv-

ing hedge funds

CogentHedge.com

dechert.com

U.S. Austin Boston Charlotte Hartford New York Orange County Philadelphia Princeton San Francisco Silicon Valley

Washington, D.C. EUROPE Brussels Dublin London Luxembourg Moscow Munich Paris ASIA Beijing Hong Kong


6/246 h m w e e k . c m

H O W T O S T A RT A H E D G E F U N D I N T H E U S 2 0 1 1

F

or first-time fund managers, ownershipand control, as well as speed of customi-sation and commercial availability, arecritical considerations when launching a

fund. There is no shortage of administra-tors who claim they can meet the first-

time fund managers every need, but SS&C is one ofthe few that provide a truly independent, comprehen-sive service. William C. Stone of SS&C talks to HF-MWeek about the business model that has taken hisorganisation from strength to strength and the tech-nological developments that will see it through thecoming year.

HFMWeek (HFM): What services do you offer tofund managers?

William C. Stone (WCS): Weare a leading provider of invest-

ment management software andoffer a full range of financial andoutsourcing services. The rangeof solutions we provide includes:fund administration, executionand trade order management,portfolio accounting and report-ing as well as a large fixed net-

work for order and post-tradecommunication.

HFM: What help do you give tostart-ups?

WCS: We offer particular guid-

ance to first-time fund managersin the initial stages of draftingtheir offering documents, which

we then review, and work togeth-er with them and their lawyersand accountants to enable thefund to get up and running. Ac-cess to expertise in the form ofour senior people is the key. First-time fund managersunderstandably have a lot of questions and they needto be able to communicate with people with the neces-sary knowledge and experience of similar structures,products and tax issues.

HFM: What can you offer in terms of speed oflaunch for fund managers?

WCS: The main attraction of our business is we are

one of the only administrators who own all of our tech-nology, so we never have to wait in line. We own andcontrol our data centres, so as soon as the i nitial offer-ing documents are signed and funds are approved we

can start the next day. A brand new fund with capitaland trading approval can be up and running within 24hours. We provide start-up funds with a full portfolioof cash management, risk reporting, investor and cli-ent reporting, web delivery, portfolio analytics, multi-prime capability and compliance.

HFM: What are the latest systems and technologythat you have in place? What will you be bringing tothe market in 2011?

WCS: We have a full range of trading systems from eq-uities and derivatives to fixed in-come, which are processed anddelivered to a very efficient net

asset value (NAV) calculation.In general, the most sophisticat-ed funds NAV are struck veryshortly after period end becauseof our efficiency. There aresome very exciting technologi-cal developments we are work-ing on and will be launchingthis year, including a number of

web portals and mobile deliveryplatforms. We are well placed to

be the first to market with theseapplications.

HFM: How does the size of your organisation help to pro-vide these services?WCS: SS&C is registered inthe US with the Securities andExchange Commission and weare trading on the NASDAQ(SSNC) and have a market capi-

talisation of $1.4bn. We are a strong company, withoffices all over the world, which allows our clients to

be able to choose their domiciles. A smaller providermay not have the numbers we do, whereas a larger pro-

vider, such as a bank, will not have as strong a strate-gic focus on fund administration. SS&C has 700 staff

committed to the outsourcing business, whose talenthas grown from within the organisation and throughacquisition. This gives us a diversity and depth of ex-

A smAller prvier mAy

t hAve the mbers

we , whereAs A

lArger prvier, sch

As A bAk, will t

hAve As strg A

strAtegic cs AmiistrAti

r irst-time mAAgers lkig t set p i the s, william c stone ss&c believes chsig

the right AmiistrAtr meAs chsig e thAt cA prvie A lly cmprehesive service,

ws its w techlgy A kws the s mArket

providing the work s

William C Stonefoundd ss&c n 1986 and

a d a ce and

aan of oad of

do. bfo aunn

ss&c, m son dd

nana onun

a of kpmg llp, an

aounn , n hafod,connu, and a -

dn of adnaon

and a nn

a Ad in., a

nana oan.

h ao on oad

of do of nln

nana, in.


7/24

a dm i n i s t r a t i o n

h fmwe e k . c om 7

pertise, which I believe is unmatched in the industry.Now, more than ever, fund managers seek out estab-lished administrators with successful track recordsand reputations and SS&C is well positi oned.

HFM: What makes your services unique in the fundadministration space?WCS: With the breadth and depth of our technology,combined with our 250 software engineers, we areable to customise our solutions to meet the uniqueneeds of high-end money managers looking for re-turns all over the world w ho dont want to be restrict-ed by systems or expertise. At SS&C we have expertiseacross a range of asset classes and different types of

vehicles fund managers use to invest in those assets.Institutional providers who offer services to smallerfunds are few and far between and fund managers re-

quire the ability to grow as the fund grows. We believeSS&Cs conversion expertise and methodology areparticularly attractive.

HFM: What do you expect to happen in terms offunds outsourcing middle- and back-office func-tions this year?WCS: I believe outsourcing wi ll continue to acceleratethroughout 2011. There was a heavy push on adminis-

trators, in the wake of the Madoff scandal, to take onmore responsibility but this seems to have slowed. I

believe that the hedge fund model and the outsourc-ing of administrative responsibilities is a positive, aslarge institutions have a difficult time cost effectivelymanaging technology, investment operations and ac-counting. Recently we converted three fund manag-ers middle- and back-office processes to SS&Csfund administration platform. They required severaldeliverables, including web-based fund and investorreporting, proven ability to scale, reliable staff and animpeccable corporate reputation. SS&C met and ex-ceeded each of these criteria.

HFM: What new challenges will regulatory c hangesbring to fund administrators in 2011?WCS: Recent legislation, such as Dodd Frank and

Basel III, are calling for a number of study groups inorder to define what are going to be the specific re-quirements. The Securities Exchange Commissionand the Commodity Futures Trading Commission, inthe US, aim to define joint reporting. This reduces the

burden on the fund industry. Capital, position limitsand stress testing will become the norm. SS&C will

be in good shape to help our clients implement all theregulatory requirements. n


8/24

www.viteos.com

YOU CAN TRUST

THE ONE

BEST THINKING.

BEST PRACTICE.


9/24h f w e e k . c 9

a n t r a t n

T

he journey from start-up to becoming a wellestablished and recognised fund can be a longand challenging process. Increased regulatoryrestrictions and reluctant investors are making

fund launches harder than ever for emergingmanagers. HFMWeek talks to Derek Adler of

ina about the launch of its new product, Primary Devel-opment Fund, and how this aims to provide a completeservice package that can give start-up funds a competitiveadvantage with minimal costs involved.

HFMWeek (HFM): Can you tell me about the new productyou are launching?Derek Adler (DA):We are oeringa new service in the form of PrimaryDevelopment Fund (PDF) in Cay-man, which will provide fund man-agers with administration, auditing,

director and legal functions as partof a complete service package. Teunderlying value of PDF is to pro-

vide a fast, simple, eective solutionfor managers in a regulated marketand this umbrella fund platform isideally created for managers in start-up situations or emerging invest-ment managers with very low assetsunder management.

It provides a low-cost solution by avoiding the higher fees of thetraditional standalone funds and isideally suited for fund assets of be-

tween $1m and $10m, uncapped.Tis cost-eective start-up solution,

which provides competitive ongo-ing annual operating costs to assistthe manager, will include monthlyadministration, valuation and shareregistry services, as well as direc-tional services and an annual audit.It will work out of the Cayman Islands as the primary o-shore jurisdiction, which will be regulated by the CaymanIslands Monetary Authority but can work across other juris-dictions depending on the needs of the investment manager.

HFM: How exactly will it work and how will it help new

launches?DA:A fund will be established as a segregated sub-fund ofPrimary Development Fund Ltd. Managers will be charged

approximately 50% of the normal rate for establishing thefund. Te individually tailored and regulated SegregatedPortfolio/Sub Fund will provide managers with the abil-ity to select their own named fund as well as the oppor-

tunity for non-regulated managers to act as investmentmanager to their fund. Tis does not prevent the sub-fundlaunching in its own right and breaking away from theumbrella structure at any point in the future. Terefore,not only are there substantial savings in the initial launchstages of the fund and with the ongoing charges but thereis also the exibility to convert to a standalone fund in thefuture if the manager wishes. Te PDF and its low-cost

basis provide the manager with the opportunity to builda track record while the fund be-comes established, which will alsoenable further capital to be raised.Tis process also minimisesthe problem of major investors

wishing to invest only in well-es-tablished funds.

Te costs involved in this prod-uct are really the main advantagefor emerging managers as normaloperational costs can be a big de-terrence for managers consideringthe launch of their own fund, dueto a lack of initial seed capital. Evenonce the fund has been launched,delays in raising further assets canalso hinder the success of the fund.o minimise the burden of seingup the fund, all the manager needs

to decide is the choice of jurisdic-tion. Tis new service will be of-fered to clients on a global basisand while available in a number ofregulated jurisdictions, the initialfocus will be in Cayman, althougha BVI structure is already under-

way. Other jurisdictions such asMalta are also available but more expensive and addition-ally with some restrictions. Te advantage of being estab-lished in Cayman is that this service can be oered to man-agers who have not yet become regulated and thereforethe conditions for this product are extremely favourablefor investments managers looking to expand.

HFM: Who else is involved and what do they contrib-ute to the platform?

H W A A H D F D H 2 0 1 1

the Prary

evelPent fun

Prve the anager

wth the PPrtunty

t bul a track recr

whlt the fun

bece etablhe,

whch wll al enable

further caPtal t

be rae

derak adlerf ifinatalk t hfmweek abut hw the Prary evelPent fun Prve a fat, Ple an

ct-effectve lutn fr fun anager

The compleTe

package

Derek Adlerac isdomiid i uk d

di is i

ci o lodo s

d fa d

nfa. edd i ed

d izd, is

dio d odi

mm o ii, isd d dmiiso.


10/24


11/24

SS&C Fund ServiCeSRecognized as the source or independent und accounting and

administration or hedge unds, und o unds and private equity.

1independentdeFinition:

Free rom the infuence, guidance, or control o others.

Visit ssctech.com/fundservices

or call +1-800-234-0556 to learn more.


12/241 2 h w k .


W

e have seen a steady increase innew launch prospects in the pastsix months. We feel this is due to acombination of factors including:

improved returns in global equitymarkets, increased risk appetite from

global investors, portfolio managers from larger hedgefunds leaving to start their own businesses, and the dis-

banding of proprietary trading desks at major banks.Te calibre of the teams we are seeing is increasingly of

higher quality than before the 2008 market meltdown, andwe view this as a direct result of allocators only seeding/incubating top investment teams that possess the pedi-gree, process and past performance to build a sustainable

business. We touch on several new launch topics below and

hopefully provide some insight into what managers needto consider as they prepare to launch a fund in 2011/12.

Develop a Business planIt is imperative to develop a business plan describing why

you (and your partners) have the ability to start and growa successful alternative asset management rm. With thecontinued institutionalisation of the industry, simply tak-ing a coage industry approach wont cut it in the currentenvironment if your goal is to aract institutional capitaland grow a scalable business. In your business plan, youshould touch on the following items:

Executive summary General company description Products and services

Marketing plan Operational plan Management and organisation Financial plan Start-up expenses and capitalisation

As a start-up business, managers should look to get asmuch bang for their buck as they can and look to align

with service providers that have this mindset and businessmodel. Knowing who those service providers are and forg-ing a partnership is oen key to a fund managers successas he or she aempts to launch.

picking primary FunD service proviDers

Like any important business decision, you will want to work with service providers who understand your busi-ness plan and investment strategy, and a group that you

feel comfortable working with. Before picking any serviceprovider, you will want to make sure the rm has name

brand recognition within the hedge fund community andconrm their expertise in dealing with hedge funds and

the specic asset class and structure you intend to man-age. Te key service providers you will need to engage arelegal, accountant/auditor, fund administration and prime

brokerage.

legal

nd leal trctre

Fees Lockups Additions/redemptions US-only or onshore/oshore, master feeder

rm leal docment

File necessary entities in proper jurisdictions (such as

Delaware, Caymans/BVI) Dra operating agreements for GP and investment

management company entities Dra employee contracts Dra compliance manual Dra business continuity and disaster recovery plan

nd offern docment

Oering memorandum, agreement of limited part-nership and subscription documents

Review marketing documents for accuracy against thePPM

Review any tax or ERISA issues

accounTanT/auDiTor

Annual audit Investor tax statements ax preparation Certify the performance of the fund for investors

FunD aDminisTraTion

Portfolio reporting Record keeping for the fund MD, QD, YD performance Liaise with auditors for audit Fund books and records

prime Broker/cusToDian

Multi-asset class, multi-currency, multi-custodian

platform Stock loan rading technology

Frank l napoliTani, concepT capiTal, givs u gs s-by-s gui

sig u u i h y h

RE ADY TO L AUNCH

Frank L Napolitani manan drector, rme

serce grop, oncept

aptal aret LL


13/24

e b k e g e

h w e e k . 13

Middle/backocesupport Portfolioandriskreporting Infrastructure(suchasocespaceandIT) Capitalintroductionservices

Key Components of Running youR fund

ulti-custodial platform:Akeyadvantageofusingabou-tique prime brokerage service provider like ConceptCapitalMarketsLLCisthemulti-custodialplatformweprovidetoclients.Weworkwithseveralofthemostrepu-tableglobalcustodianbanks,whichprovidesourclientstheabilitytomulti-primeacrossvariouscustodianswhilehavingtodealwithasinglesupportteamatConcept.

gloal tradin capailitis:ConceptCapitalMarketsLLCservesitsclientswithahigh-touch,multi-assetclass,com-

plete global outsourced trading solution.We serve asaone-stopshopforexecutionofglobalequities,ETFs,op-tions,futures,xedincomeandforex.Inadditiontohigh-qualitytradeexecution,wesupportourclientswithexpe-riencedtraderstoprovidecontinuity,whileactingasyourpartnerwhoisfocusedonyourneeds.Ouragency-onlymodelalignsourinterestwithourclients.

is manamnt and advisory:OurRiskAnalyticsTeam*providesoutsourcedriskanalyticsandmanagementser-vicestomorethan60hedgefunds,whichoversee$50bn+assets under management (AUM) across all strategies.

egroupsgoalistoidentifytherelationshipbetweenunitsofriskandunitsofreturninbothnormalandex-trememarketenvironments.eteamprovidesthefol-lowingcustomisedanalyticstoitsclients:

Exposurereporting Stresstesting/scenarioanalysisVaR Riskbudget/volatilitysizing Limitexceptionmonitoring P&Ltimeseriesandaributionanalysis Capitalallocationsimulations Investmentstrategyallocation

iddl/ac ofc support*:Inadditiontothemulti-prime/multi-custodiancapabilitiesweprovidetofundmanagers,Conceptcanalsoserveasafundsoutsourcedmiddleandbackoceandfacilitateaggregatedportfolioreporting.isserviceprovidesfundmanagerswithsignicantcost

savingsandtheabilitytoallocateallofitsresourcestotheinvestmentprocess.Conceptisoneofthefewboutiqueprimebrokerageserviceprovidersthatmadetheinvest-ment in Advent Geneva early on and has gained sub-stantialprociencyinthisstate-of-the-artsystem.Whileexpensive and elaborate, Conceptforesaw the value oftheimplementationofAdventGenevaanditsabilitytoprovide more robust reporting not readily available tosmall-to-mediumsizehedgefunds.WithAdventGeneva,we provide our clients withmulti-custodial,multi-assetclass, multi-currency reporting through one aggregatedsetofreports.Wecurrentlyworkwithapproximately15custodiansandprovideanaggregatedreportingpackagetoourclientseachmorning.

nfrastructur support and start-up srvics+:Havingassistedalargenumberofinvestmentteamslaunchfundssincethemid-1990s, ourrelationshipmanagers inthe PrimeServices Group at Concept Capital oen act as hedgefundconsultantstoourclientsduringthepre-launchstagebyhelpingthembudgettheirpre-launchandrst-yearex-penses,choosingserviceproviders(legal,audit,fundad-ministrationandoutsourcedcomplianceservicesforex-ample),generalinfrastructureitems(suchasocespaceandIT),anddevelopingmarketingmaterialstopresenttoprospectiveinvestors.Aerlaunch,wecontinuetoworkcloselywithourclientsastheytackletheongoingissuesofrunningabusiness,notjustrunningaportfolio.

utsourcd T srvics+: Concept provides a signicant

numberofourhedgefundclientswithoutsourcedITser-vices,including:

Managingandhostingdomainservicesincludinglesharing,e-mailcommunications,networkcommuni-cations, servermaintenance,networkmaintenance,andrewallprotection.

ProvidingVolPphoneserviceandhighspeedinter-netconnectivity.

AssistindraingandimplementinganITbusinesscontinuityanddisasterrecoveryplanintegrationofvarious trading systems based on manager prefer-ence.

*Afliate company, Concept Capital Fund Services, LLC+Afliate company, Concept Capital Administration, LLC


14/24


15/24

l e g a l

h fmwe e k . c om 15

be srucured or ax purposes as a parnership. Raherhan he US-based manager receiving is incenive as a ee

rom he ofshore und and being subjec o ordinary in-come ax, he US-based manager may receive he inceniveas an allocaion rom he maser eniy, in an atemp o

bene rom capial gains ax reamen.Tere are many legal and commercial drivers in deer-

mining he ideal srucure. For example, i he sraegycalls or signican invesmen in illiquid or hinly radedposiions, which are dicul o allocae among wo bro-kerage accouns, a maser eeder srucure may be pre-erred as he invesmens will be allocaed on a pro raa

basis a he maser und ye only require he invesmenmanager o purchase and sell he posiions hrough one

brokerage accoun. Also, in many ransacions involvingearly sage or seed invesmen, i he seeder is locaed

ofshore, i may preer a maser eeder srucure so haall ees and allocaions may be aken a he maser undand hus avoid he US ax regime. Conversely, employ-ing a ax-ecien sraegy or US axable invesors may

be o litle bene or derimenal o US ax-exemp inves-ors and non-US persons. Tus, a side-by-side srucureallows he invesmen manager he abiliy o employ axeciency wih he domesic und, while maximising heenry and exi poins o securiies posiions wihou re-gard o long-erm ax gains or he ofshore und.

Structuring the inveStment manager

Te srucure and domicile o he invesmen manager isprimarily deermined by he ciizenship and ax consid-

eraions o is owners. Empirical evidence suggess hahe super majoriy o hedge unds are managed by US-domiciled eniies srucured as eiher limied liabiliy

companies or limied parnerships which are axed asow-hrough vehicles (raher han as corporaions). In

circumsances involving non-US persons, i he non-USpersons own he majoriy o equiy in he invesmenmanager and heir ineress are conrolling, he inves-men manager may be organised in an ofshore jurisdic-ion o accommodae he needs o he non-US persons.

Sae regulaion oen impacs he locaion a whichhe invesmen manager will mainain is oce. Cer-ain saes, such as Caliornia, Colorado, Connecicuand exas, have compulsory regisraion requiremens

which require an invesmen manager wih an oce inheir sae o regiser as an invesmen adviser prior ohe launch o he hedge und. Many managers choose omainain oces in neighboring saes, which do no havecompulsory regisraion requiremens so as o avoid hav-

ing o regiser as an invesmen adviser.While managing cash-burn is criical or a new man-

ager, he qualiy o he rms inrasrucure canno besacriced. Having spen approximaely wo decadespracicing law in his indusry, boh as an enorcemenatorney wih he US Securiies & Exchange Commis-sion and in a privae pracice, I have had he bene o

winessing many successes and ailures. I is imporan ouse service providers who have corporae, ax and regu-laory experience in connecion wih srucuring hedgeunds. Failure o properly srucure your rm will havemaerial opporuniy coss. A rm wih srucural issuesis less likely o atrac invesmen and more likely o beplagued wih invesor liigaion, regulaory prosecuion,

limiaion on capial resources and repuaional damage.Te coss associaed wih xing a problem ar exceed hecoss o doing he job correcly a he ouse. n


16/24


17/24

a d m i n i s t r a t i o n

h f m w e e k . c o m 17

government has taken to hedge und back ofces and seladministration.

Best practices Being adapted By fund managers

Today und managers are actively engaged in reviewingtheir back oice needs and understanding what the bestpractices are in managing and running the operations ohedge unds. The ollowing are several best practicesseen in the industry: Engaging a third party to administer the domes-

tic domiciled funds. It is not a question o i onlya question o when this will be commonplace in theindustry.

Purchasing or outsourcing portfolio managementsoftware. There is a trend to avoid reliance on port-olio data and reports rom prime brokers, be-cause o the inherent risk that should a und

manager change prime brokers or use multi-primes the inormation, including historicaldata, needed to manage the portolio may nolonger exist. Fund managers have several op-tions available whether its buying and build-ing the inrastructure, engaging a hostingpartner or outsourcing the back oice in itsentirety or pieces o it to a service provider.

Seamless integration of software systemsand processes. For too long the industry hasrelied on ragmented systems and processesto meet the needs o trading, portolio, risk,compliance and inancial management o theund. Investors are quick to point out these

deiciencies when perorming due diligenceso und managers will need to demonstratethat their processes and systems are seamless.

Maintaining a redundant set of books andrecords. Fund managers are increasinglyconcerned that to saeguard everything done

within their back oice there needs to be a second re-dundant process in place, oten reerred to as shadowaccounting.

shadow accounting

Shadow accounting has been around or some time andgained traction during the inancial collapse. The prem-ise behind it is providing an additional layer o com-

ort to the und managers and investors that a secondset o books and records are being maintained or thehedge und. In cases where the hedge und books aresel administered, the und manager will engage a thirdparty, usually an administrator, to prepare a second seto inancial reports or the hedge unds. Or, in instances

where there are concerns around the post trade process-ing and reconciliation, there is another redundant ser-

vice being perormed, to insure trade breaks are identi-ied, margin calls are correct, and valuations o hard to

value assets are veriied.It is diicult or some to understand the beneits o

this need or redundancy, applying the analogy thatshould the wheels all o the bus; there is a second bus

directly behind the irst that can carry the passengers totheir destination. There are critical and tangible ben-eits to this approach as no und manager wants to see

their business ail due to operations. The risko a bad NAV, inaccurate investor allocations oincome/expenses, restatements or poor invest-ment decisions resulting rom inaccurate valua-tion o assets, and unresolved trade breaks easilyosets the additional cost to the und or man-agement company.

the Question of outsourcingThe hedge und industry is comprised o a largenumber o und managers, all working towardsa common goal o creating alpha or their inves-tors. The success o the und should be based onperormance and mitigating risk, no und man-

ager wants their success to be decimated or hindered bythe inability o their back oice to keep pace with thedemands o the portolio management team.

Fund managers are engaging in a conversationaround outsourcing into their overall back oice opera-tions or three reasons: Outsourcing selective back oice unctions such as

trade reconciliation, sotware management and oper-

ating sotware programmes, rees up existing sta andprovides a cost-eective solution to hiring internalsta and building inrastructure.

Outsourcing provides greater lexibility and aster ex-ecution o a business plan. Enabling a und managerto utilise a system or processes that have already metthe proo o concept and thereby demonstrates bestpractices in the industry.

Outsourcing creates bandwidth or und managers;the ability to have a proven solution that can grow

with their business.

To conclude, structuring a robust back oice thatoptimises investment decisions and saeguards the cap-

ital invested in the hedge und is no longer a nice-to-have but rather a need-to-have or todays hedge undmanagers. n

the success of

the fund should be

based on performance

and mitigating risk, no

fund manager wants

their success to be

decimated or hindered

by the inability of

their back office


18/24


19/24h f m w k . c o m 19

S R V I c P R o V I D R

Y

our products shape the industrys uture, but creativity can get stifed with increasingregulations, investor scrutiny, and institution-alisation. Generate synergy between vision

and operations by relying on a third-partyservice provider to take the complexity out

o launching unds, supporting your investors, and manag-ing risk. Tis article provides a perspective and several toolsto understand the inrastructure advisers need to help themdemonstrate transparency and aract investors across theglobe.

Industry trends

Te volatility in the market has brought und operations into thelimelight and caused increased re-quirements by the government reg-

ulators as well as the investor com-munity or heightened transparency,risk management and compliance.

With investor due diligence sharp-ened around und processes andreporting, investors expect advisersto evolve their processes, reportingand und structures to ensure theyare adjusting to regulatory changesand challenges while still providingexcellent perormance returns.

Increasingly, investors, par-ticularly institutional investors, areconducting ormal due diligence

assessments o operations prior toplacing assets with unds. o pre-pare and capitalise on these evalu-ations, management companiesmust augment their ocus rompurely asset management to includecomprehensive compliance pro-grammes and dened operationalprocedures. Tey must be awareo all red fags, including perceivedconficts o interest associated withinternal administration services,adviser provided valuations and a-liated prime brokerage arrangements. Any single area o

perceived administration risk can create enough concern todrive investors to dierent advisers. In an economic envi-ronment that encourages increased regulations, leaner busi-

ness practices, greater transparency and more sophisticatedreporting, advisers must take into account the entirety otheir und administration and develop an inrastructure toanticipate and prepare or investor due diligence.

In addition to the importance being placed on the op-erations and transparent reporting, investors are puing agreater emphasis on the structure the und establishes. In-

vestors are demanding products that provide the comort oa regulated entity, but also have the exposure and returns oan alternative investment vehicle. Tese include business de-

velopment companies, closed-end unds, hybrid-registeredhedge unds and hybrid-registeredund o unds.

Aside rom the investor demand,these structures are also gainingpopularity among advisers who areinterested in tapping into the Em-ployee Retirement Income Secu-

rity Act (ERISA) market withouttriggering the ERISA ownershippercentage monitoring require-ment. Advisers opting to go witha traditional unregistered productare evaluating master-eeder struc-tures versus side-by-side structures.

While the master-eeder structureprovides greater operational e-ciency and enhanced leverageabilities, the side-by-side structureallows or more investors i the undis relying on Section 3(c)(1) o theInvestment Company Act o 1940

and greater US tax eciency.

ConsultIng and ProaCtIve

suPPort For you

What does this mean or you, theadviser? It means that when select-ing a third-party administrator, youradministrators business modelshould be consultative and theyshould share their industry experi-ence to assist with any aspect olaunching a product rom design

to daily operations. Tis should include:

1. Fund Launch Consulting. Will it provide a und ex-pense projection and help with expense modelling based on

your requirements? Will it provide industry benchmarking

wIth InVStoR Du

DIlIgnc ShRPnDRounD funD PRocSSS

nD RPoRtIng,

InVStoRS xPct

DVISRS to VolV thIR

PRocSSS, RPoRtIng

nD funD StRuctuRS

to nSuR thy R

DjuStIng to RgultoRy

chngS nD chllngS

whIl StIll PRoVIDIng

xcllnt RtuRnS

H O W T O S TA R T A H E D G E F U N D I N T H E U S 2 0 1 1

Christine Waldron

serves as seir vie-

preside r uS Barp

fd Servies ad aaes

e pas eraive

Ivese Prds

divisi, i speiaises i

e iqe servii eeds

aeraive ad privaeivese prds s

as ede ds, sre

ds, ad disressed

asses.

ChrIstIne waldron of banCorP Fund servICes hIghlIghtS wht to conSIDR whn lunchIng

n ltRntIV InVStmnt PRoDuct

investor

transparencY


20/2420 h fmweek . co m


analysis or liquidity terms, management ees, perormanceees, carried interest calculations or total expense ratios?

Will it assist with und inrastructure implementation orspecial purpose vehicles such as side-pocket investments,registered oce and board o director selection? Will it pro-

vide the support and resources to assist with independentlegal and audit frm search/selection? What about helping

with operations procedures and policies, such as valuationpolicies and investment guidelines?

2. Product Design. Will your administrators legal, com-pliance, and tax teams support your investment strategyguidelines by oering insight into possible investment prod-uct construction, diversifcation, valuation procedures anddisclosures?

3. Regulatory Consulting. Will its legal and tax teamshelp interpret and describe both the regulatory require-ments as well as the operational impact to the unds general

partner and adviser? What is its take on how to implementsuccessul compliance programmes? Will it provide assist-ance with adviser registration or the new SEC require-ments?

4. Partnership. Will your administrator leverage its exist-ing relationships with industry contacts? Can you work withits experts rom an oversight capacity on even more granularmarket, investment, and regulatory issues?

Advisers should also complete a thorough assessmento the administrators servicing team, including industryand specifc product service abilities, certifcations and bi-ographies. Responses should ocus on the specifc productrequirements related to the und with respect to sta sourc-ing, eciency and the administrators capacity or training

and development. In addition, advisers should consider theadministrators technology platorms and exibility to sup-port custom solutions.

In order to ensure your administrator can not only helpyou meet these demands, but also give you the consultativemodel you need to capitalize on your investment strate-gies, your biggest question should be: can, and will, yourprospective administrator be your servicing partner? Teadministrators talent and expertise is the most importantelement o providing successul due diligence responses to

your investors. Your investors require comort that you, andyour providers und administration team, possess the vision,authority, skills and accountability to the und and investorsto ulfl the role o independent compliance oversight.

Consulting and ProaCtive suPPort For Your

investorsIt is vital or advisers to treat investor due diligence processesas they would any external audit, business risk assessment, orprocurement process. By taking the time to ully understandeach investors requirements, advisers will be able to prepareinormation and responses in advance o ormal on-site duediligence and demonstrate ull transparency o operations,procedures and the control environment.

In our experience, proactive responses highlight the advisers commitment to the investor by taking into consid-eration the nature and depth o inormation they require. A

proactive approach also allows advisers to use investor duediligence as an opportunity to strengthen their relationshipsand provide investor education, which in our experience,

S e R V I c e P Ro V I D e R

enhances investor loyalty. ypical investor due diligence wehave seen is a combination o questionnaires, site visits anddetailed calls covering the ollowing areas:

Firm overview with specifc questions on administra-tors industry experience, tenure, turnover, commit-ment to hiring and retaining qualifed personnel, insur-ance carried, internal and regulatory audit and examhistory, risk management controls, business continuityand disaster recovery processes, Anti-Money Launder-ing programme, SAS 70s, fnancials, reerences, andtechnology reinvestment with questions asking orcommentary on commitment to innovation.

Accounting overview with questions on trading, valu-ation, reconciliation, pricing, technology platorms,quality assurance and fnancial reporting or the und.

Compliance and regulatory overview with questionson oversight capabilities, flings, ability to stay up to

date with legislation, compliance checks and tax re-porting.

Investor services overview with questions on operatingsystems, online access to reports and data, print/mailservice, anti-money laundering procedures, processingand correspondence.

Net Asset Value (NAV delivery) with the ability to pro-vide enhanced NAV certifcations, which are included with an investors statement and highlight details re-garding counterparty/custody exposure, valuationpolicies compliance, percentage o valuations obtainedindependently, independent verifcation o the exist-ence o cash, investments and OC transactions withthird-parties and procedures perormed around the

calculation o management, perormance ees, and in-vestor account balances.

Custody overview with questions on service model,technology, treasury and lending services, and segre-gation o duties or operational unctions as well as areview and approval process surrounding cash move-ments.

Fees with requests or ee schedules, a projection o ex-penses, and sample contracts.

Above all, the single most important aspect o investor duediligence is ensuring your administrator can provide accu-rate and timely investor reporting. Tis is one o the big-gest concerns we are seeing rom an investor perspective.Investors want complete confdence and transparency in

the unds underlying portolio holdings, including industryexposure, credit rating and yield distribution, and individ-ual issue exposure on a monthly basis. Your administratorshould support you in all o these areas and provide exam-ples o other due diligence audits and visits theyve experi-enced across their client ootprint.

Parting thoughts

Te alternative investments industry is driving investors toperorm risk assessments o administration support. Innova-tive product structures, along with a superior inrastructurethat supports investor due diligence, gives you an opportu-nity to showcase your operations, demonstrate transparen-

cy, create investor confdence in your investment practicesand administration, and above all, secure additional assets.So, go aheadinnovate. n


21/24

L E G A L

h f m w E E k . c o m 21

O

ne of the early decisions that hedgefund managers must make when theydecide to launch a fund is to select alaw firm to prepare the funds offering

documents. Despite the importance ofthis decision, many managers are inex-

perienced in selecting counsel. Here are some of thefactors that should be considered when making a deci-sion: Experien ce how extensive is the firms experience

in organising private funds? How deep is the benchand which lawyers will be doing the work?

Market intelligence does the firm know w hat cur-rent terms are for competitive funds?

Compliance expertise in an industry that is in-creasingly becoming subject to greater regulation,does the firm have the requisite experience in com-pliance matters?

Geographic coverage many funds invest globallyand seek to raise capital from investors around the

world. Does the law firm have the necessary geo-graphic footprint to addressthese needs?

Ancillary services in addi-tion to fund formation andcompliance expertise, man-agers will require advice in a

broad array of areas, includingtax, ERISA, derivatives, intel-lectual property and employ-ment law. Does the law firmhave expertise in each of the

areas required by the manager?While it is relatively easy to dili-gence these areas, there are sev-eral other considerations thatare at least as important, but areperhaps more difficult to assess.These include the following: Is the proposed aorney an ef-

fective business adviser, or merely a legal technician?Is the aorney able to establish a good rapport with

you? How responsive will the firm be in meeting dead-

lines and answering questions? Will services be provided in a timely and efficient

manner? Higher hourly rates need not mean thatthe cost of delivering services will be higher thanlower cost by less experienced firms. Experienced

firms can often do the work more efficiently than afirm that is learning on your nickel.

While fees are important, managers should take alonger view and select a firm that will provide value and

be an effective partner with the manager in buildinga business. Also, in comparing fee quotes from com-peting firms, make sure you are comparing apples toapples. Do both quotes cover the same scope of work?

What do laWyers do?

Often the perception of the manager, as a prospectiveclient, is that offering documents are simply boilerplate, and preparing a set of documents requires littlemore than filling in the blanks.

While the need to deliver legal services as effi-ciently as possible requires attorneys to strive to cre-ate more standardised documents, one size does not

fit all. Fund documents must be carefully tailored tofit the investment strategy that will be employed bythe manager. Liquidity terms must match the durat ion

of the assets in the portfolio andrisk factors must be drafted ina manner which highlights themost relevant risks and elimi-nates those that are of limitedrelevance to the strateg y.

Before the drafting begins,time must be spent develop-ing the optimal fund structure.Many factors should be takeninto account in doing so, includ-

ing the desire to achieve thegreatest tax efficiency, consid-ering the proposed investmentstrategy and its impact on fundstructure, regulatory consid-erations and the needs and re-quirements of investors.

developing fund terms

Once the basic fund structure has been developed,the remaining fund terms must be established. Spacedoes not permit an exhaustive description of all issues

which must be evaluated. However, the following are

some of the more important considerations: Parallel vs master/feeder structure: there are ad-

vantages and disadvantages to each approach.

whLE hE nEEd o

dELvE LEGAL EvcE

EquE AonEy o

vE o cEAE moE

AndAdEddocumEn, onE zE

doE no f ALL

H O W t O s t t H d f u d t H u s 2 0 1 1

george mazin of dechert llps financial services group ouLnE hE quEon hEdGE fund

mAnAGE mu Ak whEn ELEcnG whch L Aw fm o wok wh

FUND COUNSE L : W HAT

YOU NEED TO KNOW

eorge Mazinis a parter i deert LLPs

aial series grp.

he aises liets te

strtrig a restrtrig

esti a sre

priate s, priate

plaeets serities,

strtre prts, priateeit iestig, a brer-

ealer a iestet

aiser pliae.


22/2422 h f m w e e k . c o m

H O W t O s t a r t a H e d g e f u n d i n t H e u s 2 0 1 1

A master/feeder structure is of-ten favoured to simplify trade al-location and to be able to publishconsistent returns for both thedomestic and offshore feeders.

Offshore fund: is there a needfor an offshore fund and in which

jurisdiction should the offshorefund be formed? Non-US inves-tors and US tax exempt inves-tors still prefer offshore vehicles.

While Cayman is still the juris-diction of choice for most USmanagers, it is not the only op-tion and the European Alterna-tive Investment Fund ManagersDirective is causing many man-

agers to consider other jurisdic-tions, including Ireland and Lux-embourg.

Regulatory exemptions: consid-eration must be given to navi-gating the exemptions availableunder the Investment Company Act, Securities Actand Commodity Exchange Act.

Management fees: the rate at which fees will becharged must be determined as well as the frequen-cy of payment.

Incentive fees: will a standard 20% incentive fee ar-rangement be used, or will the incentive fees reflectsome new terms emerging in the market?

EmErging tErms

Use of hurdle rate. Multi-year performance period with clawback. Modified high-water mark. Reduced fee for lo nger term lock-up. Expenses. Certain ex penses (such as legal fees, fees

payable to the administrator, audit fees and tradingexpenses) are almost always charged to the fund.Other types of expenses are up for grabs. How ag-gressive does the manager wish to be in shifting ex-penses to the fund. Possible categories of expensesthat might be charged to the fund (if properly dis-

closed) include risk management and order man-agement software, insurance premiums, travel andmarketing expenses and compliance expenses.

Liquidity decisions concerning the restrictionsthat will be imposed on investors who wish to with-draw their investment from the fund have becomethe most contentious part of negotiating offeringdocuments with investors.

Consideration must be given to the following: How frequently will investors be able to withdraw

their capital? Will there be a lock-up period during which with-

drawals are prohibited? Will withdrawals be permitted during the lock-up

period upon the payment of a fee (soft lock up)? Should the amount of capital that may be with-

drawn on any withdrawal date be limi ted by the im-

position of a gate. If so, should the gate be a fundgate or an investor level gate?

Should the manager have the ability to fund with-drawals through distributions of securities?

If securities cannot be readily distributed, shouldthe manager have the ability to create an SPV orliquidating share class?

Should the manager have the ability to suspendwithdrawals, and if so, under what circumstances?

Investment limitations; purchase of illiquid assets. While fund managers seek maximum flexibility tomodify their investment strategy to take advantageof market opportunities, investors are increasinglyseeking to constrain this flexibility. Similarly, in-

vestors are reluctant to give the manager carte blanche to purchase private or illiquid securities,and have a strong negative reaction to the use ofside-pockets to manage the funds exposure to il-liquid securities.

Transparency; reporting. With investors demand-ing a high level of transparenc y, managers must de-termine the policies they will employ in providingportfolio information and disclosing those policesto investors.

The advice provided by counsel to managers is criticalin helping them make sound decisions in developingthe terms for their fund. Counsel will explain legal re-quirements, liability issues and market practice. The

goal should be to create a set of documents for a fundthat will be viewed favourably by investors, while stillappropriately protecting the manager.n

in comparing fee quotes from competing firms,

make sure you are comparing apples to apples


23/241.800.300.3863

Our cases support every bright idea.

Check out our brilliant solutions at

casestudies.usbfs.com

Comprehensive Alternative Investment Product Solutions

Portfolio and Fund AccountingFund Administration

Custody Services

Investor Services

ComplianceTransparency and Risk Management

Treasury Services

Tax Support

ILLUMINATE YOUR

INVESTMENT INGENUITY

Your products shape the industrys future, but creativity

can get stied with increasing regulations, investor scrutiny,

and institutionalization. Generate synergy between vision

and operations by letting us take the complexity out ofyour back ofce. Our exible technology platforms and

compliance oversight help you demonstrate transparency

and attract investors across the globe. Go aheadinnovate.

Our infrastructure helps make your case clear.


24/24

w cc w

u w u

Hedge and Private Equity Fund Formation | Transactional Counseling

Compliance Services | Regulatory Representation | Litigation | Derivatives

Tax, ERISA and Estate Planning | Real Estate

551 Fifth Avenue, 21st Floor 50 California StreetNew York, NY 10176 San Francisco, CA 94111212 573 6660 415 490 0561

adis & Goldberg represents over 500 hedge and private eqity nds.bove all else, e vale or lient relationships. Or attorneys strive to provide exellent,

onsistent, pratial and efient legal servies. we distingish orselves rom other la

frms by assisting or lients in the development o their bsinesses. his omprehensive

approah has oten earned s reognition as one o the top fve la frms in the u..

or or hedge nd pratie. nvest a e mintes to learn hat or attorneys an do

or yor bsiness.

Documents

How to Start a Hedge Fund in the US