Proprietary desk traders who start their own hedge funds,
forced to leave banks by January 1, 2013, when the Volcker Rule
goes into effect, are suddenly being thrust into managing a
business and its operations as they come face-to-face with
Dodd-Frank Act regulations.
Whats happening now mirrors what happened with
star traders with winning strategies ten to 15 years ago when
money, ego and opportunity motivated them to leave to start
hedge funds, says Matt Simon, senior analyst at the TABB
Group. Only now theyre being thrown out of larger
banks, continuing on as stand-alone hedge funds.
The industry has changed since then, when the old saw had it
that all that was needed to start a fund was two guys and a
Today there are more regulations to comply with and
operating requirements to meet, yet former prop traders will no
longer be able to depend on the requisite tools and services
they had available at their former employers.
Its easy to underestimate all the facets that
the bank had taken into account and now they need to
recreate, says Bob Guilbert, managing director at Eze
Castle Integration in Boston, which provides IT systems to
about 600 hedge funds worldwide. Its a shocker;
its cold water in the face.
For starters, former prop desk traders will need to register
with the Securities and Exchange Commission (SEC) when they
have at least $150 million in assets under management. Ten
years ago they could start a fund with just a strategy, but
today Dodd-Frank makes regulatory compliance one of the top
Then there are the sophisticated operating systems,
including voice and data networks and a recovery site, that
hedge funds need to compete in todays wired world. The
systems must be resilient and redundant to minimize downtime,
and this costs money. So does the security that goes with all
In addition, hedge funds today must have
institutional-quality auditors, administrators, execution
partners, attorneys and insurance brokers, plus two or three
prime brokers, whereas lower-level service providers and a
single broker would do before.
We know that for the real money, funds have to dress
themselves up, explains Jason Gerlach, California Hedge
Fund Association (CHFA) president-elect and COO at Sunrise
Capital Partners in San Diego. Any hedge fund today has
to have a real office you cant garage or home
office it. Investors are going to come and look at your back
office. They want to touch it; they want to see the people who
work at your firm. They want to see how you execute a trade,
how you back up your data.
The cost of all that is at least $5,000 a month, five times
what it cost 10 years ago, says Chris Ainsworth, president of
the CHFA and chief operating officer of Maerisland Capital in
Newport Beach, California.
Case in point: It took two years of preparation to launch
Hunting Hill Global Capital in New York, says chief investment
officer and co-founder Adam Guren, because of the need to
search for the right providers of information technology and a
prime broker capable of working with a fund like Hunting Hill,
which invests in multiasset classes, including exotic as well
as plain-vanilla swaps, foreign exchange and options.
We needed a prime that could handle all those
things, says Guren. We saw that small primes
werent able to, so we determined that we needed to look
at the majors and that included European banks as well. We
needed execution and coverage when considering their
The decision came down to Citi and Deutsche Bank, with
Hunting Hill chosing Deutsche in the end.
Guren says operational experience will help traders in the
new environment. He learned how to run a prop desk at First New
York Securities, a privately held shop. Guren considered
leaving the prop desk back in 2009, but after taking a look at
what starting his own fund would entail, he decided to first
return to school to learn how to manage a business, getting an
MBA from the Wharton School of Business at the University of
But even that didnt prepare him for everything he
would need to run a hedge fund, so Guren made sure that his
team included an experienced chief financial officer. Still, he
estimates that it took six months to a year to make sure the
fund was run properly.
Now Guren expects to have enough assets under management
$150 million to register with the SEC by first
quarter of next year.
Hunting Hill is far from alone, says Ainsworth, whose
Maerisland Capital opened just this past March. I feel
sorry for any fund thats launching today, he says.
If you are not a big-name prop trader from a big-name
bank, you are going to find it extremely difficult.
He notes that he partners with Mark Beder, founder, CEO and
CIO, who has 18 years of investment experience all but
six of those in hedge funds and that the partnership was
a leg-up. Ainsworth worked in operations for Bank of America
and several private equity firms. Having operational
experience is very helpful, he says.
Maerisland uses multiple primes for custody, credit and
lending. Lots of funds turn to third-party systems
providers to build redundancy, making sure information is
He attributes the change in environment to the financial
Pre-'08, you didnt need to think about knowing
how to run a business, Ainsworth says. The equity
markets were booming, hedge funds as a category were very hot
anyone with a pulse and a decent strategy was raking in
money. But post-'08? Youve got to demonstrate
the business behind the fund youve got to have
robust compliance and risk management and youve got to
prove it, he says. Its a lower-margin
business, although the best managers still make
Others say the difficulties of starting a fund today
primarily reflect performance. Although acknowledging that
its a very tough environment in terms of
asset-raising and operations, Sun Capitals Gerlach
adds: Lets be fair there have been very
disappointing results and so the general negativity towards
this category is warranted. Funds havent been performing
well. The market environment of constrained volatility has hurt
On top of that, Gerlach continues, theres intense
competition. It wont mean that you wont see
good performance again; it just means were in a tough
stretch now. Sunrise Capital is a quant trading shop
a systematic trading firm with about $660
million in assets under management.
As often is the case, the largest fund will be those most
likely to survive. True, Gerlach says all funds face more
operational due diligence for trading and the back office
needed today than 10 years ago, or even five years ago, when
the amount of transparency were facing today wasnt
required. But Guren notes: Its an extra
burden on small funds.