Fantasize about playing the market with other people's money? It doesn't have to be a fantasy. The number of hedge funds - that's financialese for private investment partnerships - has grown from 1,400 to 5,500 worldwide in the past decade, according to George Van, chair of advisory firm Van Hedge. Today funds are run by former engineers, journalists, and entrepreneurs of all stripes. Anyone can do it.
Hedge funds are open mainly to a limited number of accredited (read: wealthy) investors, who presumably have a sophisticated understanding of risk. Hedge managers are thus exempt from the federal laws designed to protect mutual-fund shareholders and can dip far deeper into a bag of financial tricks - like building big short positions, investing in private companies, or playing the options game. On average, according to Van, this riskier approach produces better returns than mutuals.
Add to this fat fees - the industry standard is a 1 percent management charge on top of a 20 percent profit cut, far better than most mutual-fund runners make - and the unquantifiable perk of working for yourself, and you begin to see why hedge funds, as Van says, "are popping up like mushrooms after a heavy rain."
Broadly speaking, there are a few steps to follow in setting up your fund. The first is to draft its ground rules. If you're a wireless telecom expert and intend to concentrate your investing on start-ups in the industry, say so. Spelling it all out provides legal insulation should the market turn against you. You'll also need to determine the fund's minimum investment, investors' withdrawal rights, and the fees you'll receive. Don't skimp on legal costs - check in with a reputable, experienced hedge-fund lawyer.
Step Two, aka "the tricky part," is to find the money. Personal relationships are the name of the game here. You must approach prospective investors privately; any publicly accessible ad, even on a Web site, could turn your solicitation into a heavily regulated (and probably illegal) public offering. Attorney John Broadhurst of San Francisco's Shartsis, Friese & Ginsburg also advises his clients to set a firm opening date for the fund. "Then there's pressure on people to actually write checks."
Steps Three and Four: Buy low, sell high.
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