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The Fundamentals of Hedge Fund Management

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I recently finished reading The Fundamentals of Hedge Fund Management: How to Successfully Launch and Operate a Hedge Fund. I was interested in the book because for my job it is vital to understand how hedge fund structures work exactly. In addition, I was curious why hedge fund A. is successful in gathering assets while hedge fund B. is a failure, despite subpar returns for hedge fund A. and great returns for hedge fund B (more about that below). The book was recommended by a friend who is launching a hedge fund, and when I saw that the author mentions Warren Buffett  (pre-Berkshire), Julian Robertson, George Soros and other famous fund managers as his inspirations, I knew that this was the right book.

Many people reading this likely dream of one day setting up their own hedge fund.  The readers of this site range from college students to portfolio managers (who for some reason think I have useful advice to offer them!). The ideal person to start a hedge fund would be Larry Pitkowsky and Keith Trauner, who were former portfolio managers at Bruce Berkowitz’s Fairholme fund, and left to start a mutual fund. Mutual funds are very different than hedge funds, but Trauner and Pitkowsky had experience at a highly successful mutual fund, and were able to garner large amounts of assets due to their experience and connections (although it is illegal for new hedge funds to solicit clients from former employers, it certainly “helps” to have those connections). The book is not meant for these type of people, but rather more for the readers of this site unless Bruce Berkowitz happens to be reading this! In fact the author states explicitly that the book is not meant for someone starting a fund with hundreds of millions of dollars under management.

The book gives you a basic outline of everything you need to do to start and run a hedge fund. The author discusses the key roles of people like the prime broker, lawyer and other important players like the auditor and accountant. Make no mistake about it, when you start a hedge fund you need to make sure you are protected legally, and even if you set everything up legally you have to be very careful. For example, according to the US Patriot Act, the General manager of the fund must be careful that their clients are not involved with any money laundering involved with terrorist groups. The author described a conference where someone asked a law enforcement official what the punishment would be for the offense. The official answered 10-20 years, at which point the room fell dead silent.

The book might actually scare you as the costs for setting up a hedge fund as described in the book are $50-100k. However, I recommend reading Joe Ponzio’s  great article on the topic, where he talks about setting up a hedge fund at closer to $500.  However, it is important to realize that Joe is focusing on the initial costs, the costs to maintain a hedge fund will be far higher.

The book mentions something very important things about marketing. First the author states that in terms of getting assets 1. the people you think will give you likely won’t 2. the people who you will never imagine in a million years giving you money might be where you get the money from. I know this first hand, as I have received several emails from some high net worth individuals asking me where to invest their money. I told them the usual disclaimer that I am not a registered investment advisor, attorney, accountant etc. but I recommended one of my friends, and is less than a week he was seeded with close to $1 million.

In regards, there are some very basic things about getting assets that the author discusses. Strachman constantly stresses that the assets will never come to you, you need to go out there and get them. Whether you do it yourself, hire a marketer or other possibilities, Strachman provides more detailed advice in the book. However, it is a vital concept to understand, because if you do not have enough assets, you will not even break even on expenses, and no matter how great your returns are, you will not find more clients.

On that note, let me end off with some important stories that the author tells at the end of the book. One story is about someone who decided to run a hedge fund out of his house. He wanted to be able to see his children, and be closer to home. He built up an impressive track record, but no one took him seriously. All his potential clients did not want to invest with someone working out of their basement. He got frustrated and eventually gave up. Another analyst who was in the industry for many years and got a top MBA started a fund. He had an office and started building an impressive track record assuming the word would get out, but nothing ever happened. Finally he spoke to Strachman, who gave him some advice on marketing and actually going after clients. The fund manager now has over $100m under management.

My one criticism of the book is that it is slighlty outdated. The book was written in 2007, and Dodd-Frank made some drastic changes to hedge fund rules. The issues are beyond the scope of this article, but for example new regulations require some hedge funds to register with the SEC, before the rule hedge funds (to my knowledge) only  were required to register with the state they were incoporated in. However, regulatrions always change and numerous questions come up so you will still want to speak to an attorney even if this book was brand new. Strachman is very nice, and provides his email address in the book and offers readers the opportunity to contact him with questions.

Overall the book is fantastic. It is a relatively quick read, and explains everything you need to know about starting and running your own hedge fund. I have recommended this book to numerous friends, who are starting hedge funds or already run one. If you fall into this category I highly recommend recommend this book, it simply is a must read. Additionally, the book covers all the topics you need to know without boring you with detail, in fact it strikes a great balance between informative and does not burden you with too much detail.

To purchase this book on Amazon.com click on the following link-The Fundamentals of Hedge Fund Management: How to Successfully Launch and Operate a Hedge Fund (Wiley Finance)

Disclosure: I receive free books from book publishers and authors asking me to review them. In addition I sometimes request specific books that look interesting. I try to review the books that I think will be the most interesting, and specifically requested this book from Wiley Finance. I have a material connection because I received a free copy of this book from the publisher. In addition I receive a small commission if you click on the above link and buy the book (or anything else) from Amazon.com. However, it does not cost you a penny more.

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