The Possibility Of Starting Hedge Fund Coops
This article explores the theoretical possibility that existing internet technology soon will facilitate the rise of investment managers with a nonprofit agenda something like Newman's Own, eventually donating millions to Greenpeace or other charities--while in place of salad dressing and pizza, supplying respectable performance for investors large and small. To my knowledge, no such trend yet exists. "Socially responsible investing" and "venture philanthropy" might be called aggressive charity in liege to investing--but CIFF seems the only prominent example of aggressive investing in liege to a charity, and only partly so. For those who believe that charity is necessary to democracy as a correction of under-empowerment, and that investing is empowerment par excellence, this may seem similar to voting for women's rights while not empowering women with the right to vote. However the universe, Ebay and Google were all created suddenly from relatively nothing. So look out for small groups of idealists, perhaps in Armani or perhaps in sackcloth, but with organizational skills and investment savvy. Perhaps they soon could blaze new avenues for charities and investors.
All current choices for investment management are often distrusted. As everyone knows, the average mutual fund often underperforms the S&P index. An individual can often do better. Warren Buffett famously whined to Business Week in 1999 that he could gain 50% annually if only he had less loot: "It's a huge structural advantage not to have a lot of money." A Hedge Fund can be as nimble as the individual while having some of the resources of the institution but its problems are...
- Risk of mismanagement, shutdown-after-bad-year, outright fraud.
- High annual fees and profit-sharing fees.
- Limiting minimums: usually $5,000,000 net worth needed to invest.
- Limiting maximums: the more well-run, the sooner the door closes.
Why nonprofit financial management might do better. There is an as-yet unexplored possibility of investment management by organizations with charitable agendas such as funding Greenpeace, WWF, Red Cross, etc. To maintain integrity, charities may be forced to eschew corporate donations or investments. However, this may be all the more reason that a beneficiary organization may wish to do otherwise. Such a possibility is termed here a "Hedge Fund Coop" to highlight the motivating spirit. However this new entity might not operate a Hedge Fund nor be a cooperative, which can suffer from too many cooks in the kitchen. Newman's Own even seems to know better than to register as a nonprofit entity. At any rate, what is being loosely-termed the Hedge Fund Coop may shorten the shortcomings of investment institutions. To shorten this article as well, explanations are brief. If anyone is interested enough to desire clarification about anything, please feel free to comment below.
- Spiritual appeal. Supporting needy causes instead of high-paid managers.
- Less mismanagement risk. Continuity and transparency via individual mirrored accounts.
- Instant trust funds, revocable or irrevocable. Easily done if personal decisions are not required.
- Tax benefits. The Coop might establish trust situs in any favorable state.
- Bequeathment harvesting. 10% or so to the Coop when a trust dissolves.
- Idea harvesting. Aging investment savants may share and mentor their ideas.
- Low overhead. Idealistic managers well-content with $10,000 monthly or so.
- Unlimited asset management. Autotrading, discussed below, enables unlimited strategies.
- Philanthropic Funds, Micro Funds and turbocharged management. Discussed below.
Why a Hedge Fund Coop might begin with mirrored autotrading. With the internet, we no longer need tens of millions in capital to establish something like a Hedge Fund. Anyone can establish a widely-advertised track record, merely by posting decisions at autotrading sites, where people sign up to "mirror" or automatically imitate every decision. Mirror-management can be done with no actual money. To be taken seriously, the Coop needs only $50,000 or so AUM (Assets Under Management).
Mirrored autotrading has significant pitfalls. Many autotraded accounts take high risks with reasoning as questionable as encountered by Lewis Carroll's Alice behind the looking-glass. There may be software fees and limited choices of brokers. Mirroring accounts often experience sub-par performance due to bid/ask spread. Nonetheless, autotrading can include sensible strategies. Sub-par performance can be minimized with inexpensive software and behavior modifications. A reputable mirror-manager can recommend a reputable financial planner, to be sure strategy choices are appropriate. Technically, there do not seem many wrinkles which could not be ironed out.
At minimum, mirrored autotrading could be considered a significant enhancement of the well-established newsletter genre. Investment newsletters are generally obfuscatory in performance claims and generally restricted to simple suggestions which, even so, only a minority of investors has the discipline to follow. With mirrored autotrading, the suggestions are automatically followed, which may include options and short-selling, and a clear record is generated.
Philanthropic Funds, Micro Funds and turbocharged management. Eventually, a Hedge Fund Coop might comfortably manage any size or type of account at any broker, either as trustee or advisor. A true Hedge Fund is perhaps the ultimate such possibility. However, a typical Hedge Fund charges 2% annually plus 20%-of-profit above a specified benchmark. This encourages a "heads I win, tails you lose" potential with investors often at the raw end. Consequently, federal accreditation laws tend to limit Hedge Funds to being an instrument for increasing wealth for those who are wealthy. Thus creating somewhat of a philosophical lose-lose for a Coop whose agenda includes equal opportunity.
Perhaps this dilemma can be resolved by catering to venture philanthropists--who might agree to 50% profit-sharing which goes to an Emergency Pool, and also seed the Emergency Pool with interest-free loans. This Emergency Pool could gradually repay these loans while investing with a leveraged long-short strategy--while also being required to make interest-free loans to the Hedge Fund after quarterly downturns, with repayment required only from above-peak gains. Thus in compensation for the high profit-sharing, "turbocharging" the rebounds with no added risk to investors. The Emergency Pool should budget something like 1/3 of assets for turbocharging annually, thus possibly draining itself during a recession. Nonetheless, inasmuch as investments are worth investing in, inevitably amassing huge assets. In addition to charitable possibilities, there can be enough with which to turbocharge some ordinary trust accounts managed by the Coop, perhaps in exchange for increased "bequeathment harvesting" as listed above. Thereby indirectly sharing Hedge Fund gains with average investors and with charities. To minimize red tape, no claim need be made except having discretionary access to free leverage.
A superior possibility, using new legal standards pioneered by Bernett Capital Management, is that a Coop might directly challenge the norms by creating a Hedge Fund that accepts investments as low as $1,000--and if necessary to remain within practical limits, gradually lowering the maximum that each investor may compound annually. Thus turning the traditional rich-get-richer bias upside-down: assisting the largest possible number of investors and being equal to all. I intend to research the possibility of Micro-Investment Hedge Funds in depth, and will post findings in the comments below.
Incubating a Hedge Fund. As explained above, mirrored autotrading alone might enable sufficient success for a Hedge Fund Coop. Also in my small opinion based on perusing articles, anyone interested in starting an actual Hedge Fund should read every related book, and not bother reading without $100,000 AUM, an able assistant or partner and of course a strong investment strategy with high gain/risk. However if those conditions are met, then a typical first step is forming an Incubator Hedge Fund. Numerous legal firms advertise this process as costing around $3,000 in fees and registrations, plus monthly fees for an accountant to certify the performance record. An Incubator Fund cannot advertise or accept outside investment. However it is designed for seamless upgrading to a full-fledged Hedge Fund. Therefore perhaps an Incubator Fund that has successfully invested $100,000 can mainly pass a few legal hurdles to solicit large investors.
Of course, any such plan will need to be worked out with a lawyer. Straightforward information is posted at InvestmentLawGroup.com on "Launching An Incubator Hedge Fund." Many basic questions are also answered at HedgeFundLawBlog.com. MergersAndInquisitions.com posts a sobering 2011 article: "So You Think You Can Start a Hedge Fund?" This and most articles seem to imply that it is not very feasible to operate a Hedge Fund with less than $10 million AUM. This seems to concur with the minimum requirements for prominent databases used by investors to find Hedge Funds. However HedgeCo.net operates a database which seems to require only $1 million AUM, and also posts advertisements for "Start A Hedge Fund" packages costing as little as $10,000. FWallStreet.com also posts a roguish 2008 article, "Start Your Own Hedge Fund," which implies that do-it-yourself costs might be less than $3,000. Bernett Capital Management also points out that federal law does not require any minimum AUM, nor registration as an investment adviser until there are 15 investors, in its page: "What is a Hedge Fund?"
The chances for Hedge Fund Coops seem hopeful on the whole. It would certainly be best if one well-heeled and well-experienced investment manager would take up the cause. Nonetheless, there also seem to be ways for a well-planned group to launch some form of Hedge Fund Coop with just enough capital to demonstrate viability. Having done so, it seems likely that some investors and celebrities would like to participate. Even more potent may be the fact that, in contrast to the competitive stance of for-profit innovators, the first Hedge Fund Coop may directly encourage and finance new variants. As stated and illustrated above, the same goals may be achieved in numerous ways, not necessarily involving a Hedge Fund nor a cooperative. Therefore it seems possible that Newmanesque organizations could soon be providing a compelling new genre of financial services, while providing new ratios of empowerment over exploitation for such charity subjects as Children and the Earth.
The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.