18 Oct What is the minimum amount of capital required to start a hedge fund?
There is not a legal minimum, but there is a practical minimum based on cost and budget of the firm starting a fund. The expenses of operating a fund are 1) investment advisory fee; 2) fund accounting and participant recordkeeping; and 3) independent audit, tax return and K-1 preparation at fiscal year end (usually calendar).
If the fund is going to pay its own expenses, which is likely the goal, the breakeven is a function of the expense ratio. To calculate the breakeven, take the expected expenses stated as a $ amount and divide by the expense ratio.
An investment advisory can waive its fee, and most funds do at lower asset levels to remain competitive and not kill the net return of the fund with expenses.
Before 2008 many funds did their own fund accounting and participant recordkeeping, but few investors will accept a self administered fund after Bernie Madoff and Stanford Financial stole billions with falsified fund accounting and participant statements. Hiring a good fund administrator will carry an asset based fee of 6–9bp with a minimum $25–35,000 per year.
The cost of year end independent accounting is typically $13–17,000.
There are really two breakevens, the first to cover the expenses while waiving the investment advisory fee, and the second to cover all expenses and receive the full investment advisory fee. Both are a function of the expense ratio, which in turn is a function of what your investors will accept. Fund expenses are a direct subtraction from fund performance on a net basis.
For illustration, assuming an investment advisory fee of 60bp and expense ratio between 75bp and 125bp, the breakeven without investment advisory fee ranges from $4.5 to 7.5mm, and with investment advisory fee between $9 and 65mm.
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