Should I start an Asian hedge fund?

If you are one of the many wannabe Asian hedge fund managers, it is the vital question. The answer? In short, boy, is it tough at the moment!

This is, perhaps, counter intuitive - in 2006 we saw the highest volume of new asset flows into the industry for many a year, $127bn (€94bn) according to ‘Hedge Fund Review'. Quarter one of 2007 saw a further $60bn raised. So we seem set for another year of rapid growth.

On average in Asia I see around three new managers a week, all at various stages of pre-launch planning. The prime brokers tell a similar story. The volume of new assets being raised globally, the intense worldwide interest in Asia and the huge rewards on offer for the successful make starting a new hedge fund business very attractive to the entrepreneur, the disaffected and the recently bonused. Asia abounds with all three.

You need four principal ingredients to starting up a hedge fund:

n
Working capital for the fund manager;

n Personnel;

n Regulatory licensing and taxation concerns;

n Investment capital.

I have always advised managers that a minimum of two years' worth of expenses should be held in cash
at the start of any launch. A business always takes longer than you think to mature and to expect to be cash flow positive in under three years is foolhardy. The costs of running a business for two years are rising. Office rents in the major Asian financial city centres are increasing exponentially. Front, middle and back office staff are
in short supply and their cost is rising.

The burden of increasing regulation and compliance is forcing up costs as well. In addition, would-be investors from Europe and North America are attuned to a level of systems architecture (trade order management, portfolio management and risk) that is expensive to build and time-consuming. It's virtually impossible to borrow this money from a bank. Traditionally the money manager finds it himself or brings in a sugar daddy to provide it. If you take the latter course you will have to give up a large piece of your economics.

Dependent upon the strategy a manager may need as much as $1.5m in cash. All of this is at risk. Spend it and fail as a business and you won't see it again. A high proportion of new Asian managers are first generation - that is, they are coming out of broking houses, long-only asset management businesses and investment banks. Not all can afford to risk this amount of capital. School fees and mortgages are important considerations even for a hedge fund manager.

There are some solutions. Put your office in a less ritzy part of town, ‘soft dollar' your technology costs, bring key staff in as equity owners rather than as salaried employees. But all imply some form of compromise, no matter how slight, and all these solutions, at the margin, will affect how your firm is viewed in the marketplace.

he days when a hedge fund built around just one employee could expect to prosper are gone. Everyone needs to go on holiday. As investment strategies in Asia become more complex, so the need for more and higher quality staff increases. Portfolio managers, traders, sales people, compliance and middle office personnel. The competition is now intense for good quality people.

The talent pool was not large to start with, given the hollowing out of fund management talent in Asia after the 1998/99 financial crisis. But now financial institutions are back in force. Investment banks everywhere are staffing up for China and India. Prime brokers and administrators are thicker on the ground too in response to the growth in the hedge fund industry in Asia. The advent of the large US-based, mainly multi-strategy houses in the past few years has
further intensified the competition. It feels like 1994-96 all over again, when staff were not only impossible to find but really hard to cling on to, as wage inflation took off. If you find good staff, make sure you pay them well. As a start-up you may even have to build in a premium, as employment with you is riskier than with an established institution.