industry expert phillip chapple's key steps to starting a ...€¦ · some key considerations...

BLOOMBERG FOR HEDGE FUNDS

A Bloomberg Professional Service Offering

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Industry Expert Phillip Chapple's Key Steps to Starting a Hedge Fund

CONTENTS

02 GETTING STARTED: SEPARATE THE FACTS FROM THE HYPE

04 LEVERAGE: DO YOU REALLY NEED IT?

06 COMPLIANCE: FEEL THE FEAR AND DO IT ANYWAY

08 FINDING PARTNERS: IT’S ABOUT PAYING FOR THE BEST

SEIZE THE OPPORTUNITY>>>>>>>>>>>>>>>>>>>Taking the right steps in establishing a new hedge fund is key to long-term success.

Phillip Chapple from KB Associates highlights some key considerations for the start-up stages of a hedge fund.

Interview with Phillip Chapple, KB Associates – June 2013 BLOOMBERG FOR HEDGE FUNDS // 01

YOU’RE NOT GOING TO BE TOP DOG ANYMOREYou’ve probably heard the stories. All they needed was a small office, an Excel® spreadsheet and a few million pounds within a year they were sitting on a half-billion pound fund. Five or six years ago, hedge fund managers could decide who invested in them. Regulations weren’t as tight and demand outstripped the available product. No wonder they did so well. But, things have changed, and anyone entering the market has to adapt to a new, challenging environment.

THE SCENE HAS CHANGEDHedge funds are no longer a cottage industry. Business models have evolved and scrutiny is much more intense. Both the industry and its investors have matured and become more sophisticated, so today your approach to starting a hedge fund has to be well-planned and rigorous. But, get it right, know what you are doing and the opportunities are still very much there. It’s about leaving no stone unturned.

SO WHO’S IN CHARGE NOW?The days when investors talked directly to hedge fund managers are long gone. First, they turned to the funds of funds, then to the consultants. Now both camps are offering new platforms containing a wide selection of funds. Investors like it this way: they know the platforms have performed detailed due diligence on the funds, checking and rechecking that everything is safe. These platforms have become dominant in the industry. To be successful today, you must establish a presence on the platforms.

ANYTHING ELSE I NEED TO WORRY ABOUT?There is more regulation now than ever before. You’ve probably heard of the Alternative Investment Fund Managers (AIFM) Directive, which is in the process of being implemented. It aims to offer more stability and enforce greater transparency to fund operations across the EU. What does this mean for you? You need time, effort and the financial resources to become compliant.

NOW THE GOOD NEWSTo be accepted onto platforms, you will need to pass due diligence checks on your business operations–but getting this right isn’t difficult.

Here’s how it works. The platforms create their portfolios by whittling down alternative investment vehicles. They don’t want to spend hours excluding funds from their list, so there are obvious red flags to avoid:» Do you use unsecure smartphones?» Or a wireless router that could be hacked?» Are cages of equipment left unlocked?

These questions might seem trivial, but routine carelessness can get you removed from a platform list at the stroke of a pen. It’s up to you to dig into the detail, then simply fix anything that needs to be improved.

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GETTING STARTED: SEPARATE THE FACTS FROM THE HYPE >>>>>>>>>>>>Keep that element of risk. Investors still find it attractive. Just make sure that it’s nowhere near your infrastructure.

HOW DID WE GET HERE? A lot has changed in the few short years since the economic crisis. Maybe that’s why you’re reading this?

But the hedge fund industry hasn’t just transformed, it’s turned completely on its head. But what does this mean for you and your start-up plans? Who are the real deal makers now? And have you mastered the devil in the details?


RISK IS STILL ATTRACTIVEHere’s the most important thing: for a while the hedge fund scene almost lost its lustre. Consultants sold the idea of safety to investors, but returns were no bigger than the banks’. What many forgot is that hedge funds should represent the 10—15% of a portfolio that really excites. Investors still want risk, but they want it to be understandable and transparent. Your fund doesn’t have to be dull. Make it interesting and celebrate the risk you offer–it’s what makes your fund unique. Just ensure that it’s wrapped up in your alpha proposition–and never in the weakness of your infrastructure.

BLOOMBERG FOR HEDGE FUNDS // 03

IMAGINE A SCENARIOChinese environmental funds–it sounds like a risk. But where does that risk really lie? How about this for an idea: » You focus only on equities traded on the Hong Kong

stock exchange» You settle everything in dollars

Here, you have avoided the two main risks: local infrastructure and currency. You’ve still given your investors risk exposure, but in a well-considered and controlled package.

GETTING STARTED: THE THREE-POINT TAKEAWAY1. You need to think like a service provider; you can’t always dictate terms.

Do you understand your investors’ viewpoints and needs?

2. Respect your conduits to investment and make sure you’re one step ahead. Funds of funds, consultants, platforms–before accepting your fund, they will scrutinize your operations and infrastructure. And, if they reject you, they are not obliged to tell you why. Are you prepared to put in the work, anticipate every failure point and stay ahead of their changing stipulations and requirements?

3. Be as transparent as you can be, especially when it comes to risk. You don’t need to run your business like an open book and throw away your competitive advantage, but you must strike a balance. Are you able to articulate the risk and show that it’s placed where it should be?

Interview with Phillip Chapple, KB Associates – June 2013

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LEVERAGE: DO YOU REALLY NEED IT? >>>>>>>>>>>>Ask yourself these questions. Is there only one way of doing this? Could you do things differently?

GET READY TO TALK THE TALKYou are fired up for this. You’ve put in the work to understand the changing scene and maybe you even have a compelling strategy in place. Now it’s time to get out there...

TURN OFF THE AUTOPILOT The hedge fund industry has grown up in recent years. But that doesn’t mean there is an established status quo. When it comes to getting the trading leverage you need, there is more than one way of doing things. Think about what you really need.

ASK THE TOUGH QUESTIONSSome banks have a culture that makes it difficult to pose questions–people worry about seeming uninformed. In the hedge fund industry, things are completely different. As a hedge fund manager, the buck stops with you, so you should be questioning potential suppliers until you fully understand who they are, what they’re doing and why they’re doing it. Leave no room for assumptions and keep a firm hold on the details.

DO YOU REALLY NEED A PRIME BROKER? Many people enter the start-up phase assuming they need a prime broker. But if you aren’t seeking leverage, this isn’t necessarily the case. Brokers also offer you add-on services like consultancy or capital introductions, and you’ll need to assess these on a case-by-case basis to determine their real value to you. Just remember, leverage is what prime brokerage is all about. Today, many funds launch without any leverage at all.

IT’S TIME TO STAND OUTSo how can you raise capital without leveraging your strategy? The answer lies in the uniqueness of your strategy and how it appeals to investors. Many successful start-ups are entering the market with niche and idiosyncratic strategies–they create a buzz around their expertise in a particular market or sector. This approach is highly focused and rarely relies on leverage from banks or deals from seeders. So, if your strategy is unique–and it really should be if you want to make your mark early–it’s OK to think differently.


WHATEVER YOU DO, KNOW THE RISKSOf course, you still might need to use prime brokers for leverage or for add-on services like capital introductions. Just be sure you ask the important questions: » What’s your potential prime broker’s policy on

rehypothecation? » How’s the credit rating looking? » How will your assets be separated and protected? » Can you get a custodian arrangement that’s financially

viable for you? » What happens if the bank goes out of business?

You will feel more comfortable making decisions once you know the answers.

LEVERAGE: THE THREE-POINT TAKEAWAY1. Have the confidence to challenge old perceptions.

When you are new to an industry, it’s easy to follow established players and do things the way they’ve always been done. Are you are prepared to think differently?

2. Ask the questions your investors want answered. Choosing the wrong prime broker can cut you off from potential investors in one swift stroke. Are you prepared to do the detailed research to find the right one?

3. Stay focused on your strategy. It is easy to feel bogged down by research, especially when you’re talking to suppliers in the early stages. Remember, it is your strategy that will ultimately help you to succeed, so never lose sight of your initial vision.

BECAUSE YOUR INVESTORS WANT CLARITY EVEN MORE THAN YOU DOInvestors don’t necessarily mind risk in your strategy. As long as it’s transparent and understandable, risk exposure is almost the only thing that will make you attractive as a start-up. The one thing investors do not want to see and will avoid is risk in your infrastructure. So do your homework and build their confidence in your thoroughness. Demonstrating an in-depth knowledge of prime brokers, and why you should or shouldn’t use them, is a great place to start.


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COMPLIANCE: FEEL THE FEAR AND DO IT ANYWAY >>>>>>>>>>>>>>How can you make life simple? Just follow the rules.

NOBODY LIKES RED TAPEBut when you are starting a hedge fund, it’s a simple fact of life. Follow some straightforward advice and compliance could be a lot less painful than you think…

COMPLIANCE IS NOT SOMETHING TO IGNOREBelieve it or not, some entrepreneurs will exploit regulatory loopholes and try to avoid manager authorisation. This isn’t a sensible approach. For one, your potential investors will take flight at the first hint of a compliance risk. And there’s even more at stake than that…

BECAUSE THE PERSONAL PENALTIES ARE SEVEREThere really is no place to hide. To manage a hedge fund from the UK you need to get authorised. It's a legal requirement. Once you are authorised, you will be on the hook for absolutely everything and shoulder the blame for any compliance breach. It doesn’t matter whether the breach is intentional or not—and you won’t be able to blame suppliers. The penalties can result in the failure of your business and even a lengthy prison sentence.

IT’S CLEAR WHAT YOU NEED TO DOThere’s really no mystery to compliance. Even if you are prepared to cut corners and take risks, your investors won’t follow suit. The market has matured and investors demand robust regulation. Typically, that means oversight from the Financial Conduct Authority (FCA).

IT’S (ALMOST) CLEAR HOW YOU’LL NEED TO BEHAVEHow has the market matured? Well, there is more clarity and less ambiguity about what you–as an individual–can and can’t do. There are areas, like personal account dealing, that might be worth avoiding completely. Opinions on this differ, but any perceived conflict of interest can harm your business. Investors are increasingly unforgiving of unethical practices and activities such as front-running your fund can do permanent damage to your reputation.


EXPERT HELP IS AT HANDGetting compliance right is easier than you think, but it isn’t something to do alone. Make sure you take advice from specialists: your lawyers and experienced FCA consultants. People who have worked for the FCA are particularly useful as they have a deep understanding of your obligations. They can answer questions such as: » What are the compliance differences between the UK and

U.S. regulatory regimes? (There could be many more than you realise.)

» How are requirements changing and what’s coming next? (The AIFM Directive anybody?)

» What must you do on a daily, monthly and annual basis? (For example, how will you make sure that every communication is fair, clear and not misleading?)

AND IT WON’T COST YOU THE EARTHThe cost of compliance is not prohibitive: » FCA Application Consultant — £10,000

(rising to £18,000, depending on who you use)» FCA Application Fee — £5,000» Ongoing Support from Your Compliance

Partner — £12000 to £16000 per year

Full compliance could cost under £50K in your first year. When you are starting up, it could be some of the best money you spend.

COMPLIANCE: THE THREE-POINT TAKEAWAY1. Find people who have been there and done it.

Use experienced FCA consultants to get your start-up authorised with the FCA. You will probably get there in less than six months. Do it yourself and the period could be indefinite.

2. Consider how your compliance effort is perceived. Having external and experienced support is a requirement for many investors–the more professional your approach, the better. In contrast, investors will lose confidence if they see you flying solo.

3. Stay one step ahead of the game. The AIFM Directive is due to be written into EU law by mid-2013. No one has the complete picture of what will change yet. But one thing is certain: specialist support will help keep your back covered.


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FINDING PARTNERS: IT’S ABOUT PAYING FOR THE BEST >>>>>>>>>>Shop carefully. And accept that some things in life are worth the price.

THE FINAL PIECES OF THE PUZZLENow it’s time to put the rest of your infrastructure in place: lawyers, accountants and the rest. You need to tread carefully, because these are not quick or easy decisions. Investors will make judgements about your business based on who you choose.

THE BETTER THE LAWYER, THE HIGHER THE RATE When you’re starting out, you need lawyers to draft your offering memorandum. It will cost between £60—100K and it is better to pay towards the most experienced and recognised in the industry. There are really only five or six firms that are specialised enough to satisfy investors: their lawyers are dedicated specialists, leaders in the field and believe they are worth every penny. If you want to attract investors, they are probably right.

WHAT ABOUT FUND ADMINISTRATION?This is a key decision for you. Your fund administrator will value your portfolio, deal with investor subscriptions and redemptions and make sure you get paid on the basis of your calculations. It’s an important consideration for your investors, too. This is their checks and balances and they will want to know who’s doing it, how specialised they are and whether they have the right experience. While many fund administrators might be suitable for basic operations, you will need to look further if you have a complex strategy involving a number of jurisdictions.

No two administrators are alike–some are attached to banks, others will be more niche experts. It’s about doing your research and making sure you know what you are getting.» Will you get reports daily or monthly?» How often will they do reconciliations? » What are their costing and liability profiles? » Will your administrator be able to scale and grow

with you as you expand?

These are just a few of the questions you should ask. Just be sure your final decision is based on what you and your investors need and want and not merely on who is cheapest.

BUILDING THE RIGHT BOARD OF DIRECTORSHere’s a dilemma: established managers aren’t under much pressure to upgrade their boards, at least not yet. Start-ups, however, are expected to display all the rigour of a 21st century set-up. That means:» Three fully independent board directors (one with legal

experience, one with accounting experience and one with operations or investment management experience)

» Individuals who are not working for your administrator, your lawyer or your investment manager

» Individuals with relevant experience» Individuals in the right jurisdictions» Individuals with the time to serve

(e.g., not on too many boards already)

For a start-up, this is no easy task. There just aren’t enough people with the right qualifications and background to satisfy demand. So your best plan of action is to get recommendations: talk to your lawyer, your administrator and your prime broker, if you have one. Make contact with every possible connection you’ve got and be prepared to pay for the best.


THEN THERE’S ACCOUNTANCY AND INSURANCEThis is quite simple:1. Insurance is relatively cheap, so there’s no excuse to

ignore it. Your investors are going to expect protection.

2. Accountancy is a necessary evil: the VAT, the payroll, the auditing. Just make sure you get advice that suits your needs. Again, remember that your investors care about who you use, so stick with the established players.

Your accountants may also offer tax planning and the cost can vary greatly, so assess carefully whether you want it or not. These days, tax loopholes are closing as fast as they are found, so you might prefer to stay squeaky clean.

MAKE SURE YOU HAVE CHECKS AND BALANCES The right partners can provide a degree of protection and comfort for you and your investors. But the story doesn’t end there. Even when you employ the best in the business, there’s still room for human error. Unfortunately, if mistakes are made, you and your board are ultimately responsible. In fact, recent court rulings have confirmed that it remains your responsibility to check the work of your suppliers.

How do you handle this? You need to employ an operations person–a very good one–who will monitor and control your processes and operations and make sure suppliers are doing what they should.

FINDING PARTNERS: THE THREE-POINT TAKEAWAY1. Think like your investors.

They’re probably more interested in who you employ than you are. Have you researched the suppliers that are at the top of their approved lists?

2. Be willing to pay for the best. Set-up costs can seem high, but paying for experienced and respected partners can work out well in the long term.

3. Every choice you make is crucial. That includes who you employ internally. Do you have the right operational team in place to ensure suppliers are carefully controlled?


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To find out more about Bloomberg for Hedge Funds and how we can help with your start-up plans, please contact us on +44 (0) 203 216 4804 or email [email protected] : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : :

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The content in this document was provided by Phillip Chapple and does not reflect the views or opinions of Bloomberg Finance L.P. or its affiliates. Bloomberg Finance L.P. and its affiliates do not express an opinion on the content in this document or its accuracy or completeness. Any reliance placed on this document is at your own risk. All opinions, estimates and other information included in this document constitute the judgment of Phillip Chapple as of the date hereof and are subject to change without notice. ©2013 Bloomberg Finance L.P. All rights reserved. 53666490 0613

industry expert phillip chapple's key steps to starting a ...€¦ · some key considerations...

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