Here's how to start a hedge fund in Canada. Check out this guide to launch, comply, and succeed
Starting a hedge fund can be a compelling opportunity for financial advisors looking to scale their investment management strategies and attract more sophisticated clients. In this article, Wealth Professional Canada will discuss what you need to know about how to start a hedge fund.
This guide is especially created for those who are just starting in their career as wealth professionals. If you’re an experienced one, this can be a good refresher. Feel free to share this article with your newbie colleagues!
How to launch and manage a hedge fund
Are you currently working as or aspiring to be a financial advisor? You might consider launching a hedge fund to offer alternative investment strategies to your clients and build an institutional-grade asset management business.
Creating a hedge fund in Canada can be a rewarding opportunity for both new and experienced financial professionals. However, establishing one requires careful planning, regulatory compliance, and operational execution. Here are the steps to take:
- understand what a hedge fund is
- assess your eligibility and capabilities
- choose a fund structure
- register as an advisor
- comply with regulatory requirements
- maintain ongoing reporting
- develop a compliance program
- raise capital from qualified investors
- market the hedge fund
- launch with a good seed capital
Let's discuss each step below:
1. Understand what a hedge fund is
A hedge fund is a private investment fund managed by professionals who aim to generate high returns using various strategies. These can include investing in traditional assets as well as uncommon and risky investment vehicles and financial instruments. For instance, hedge fund managers might use:
- leverage to amplify returns
- derivatives or underlying assets
- nontraditional or alternative investments
Hedge funds are structured to outperform average market yields and often use hedging techniques to reduce risk. For instance, they might invest in assets that tend to move in opposite directions to balance potential losses.
Due to the complexity and risk involved, hedge funds are generally open only to accredited investors who meet certain income or asset thresholds. Common investors include:
- high-net-worth individuals
- government agencies
- insurance providers
- pension funds
These funds are usually illiquid, requiring clients to commit capital for extended periods, such as a one-year lock-up, with limited withdrawal windows. Watch this video to learn more about hedge funds and how they operate in Canada:
In terms of innovation, hedge funds are starting to take advantage of ChatGPT to improve their services.
2. Assess your eligibility and capabilities
Before starting a hedge fund, it’s best if you have:
- a proven investment strategy and track record
- experience managing capital and assessing risk
- an understanding of Canadian securities law
- a business plan for scaling and distribution
- access to legal, accounting, and fund administration support
Financial advisors who are already registered as portfolio managers are well-positioned to take the next step. Those who have a Chartered Investment Manager (CIM) or a Chartered Financial Analyst (CFA) will likely thrive as hedge fund managers.
3. Choose a fund structure
Most hedge funds are structured as limited partnerships (LPs) or trusts. A hedge fund structure usually includes:
- General Partner (GP): The entity that manages the fund and has unlimited liability. This is usually your asset management company
- Limited Partners (LPs): The investors in the fund. They have limited liability
- Investment Fund Manager (IFM): The registered person or firm responsible for managing the fund’s investments
- Trustee or Fund Administrator (if structured as a trust): The one in charge of handling operations and compliance
An LP is often preferred for hedge funds because it offers flexibility and tax transparency. In some cases, an offshore fund structure might be used to attract non-resident investors.
4. Register as an advisor
Hedge fund managers must be registered as an advisor or rely on a registration exemption. They should adhere to other applicable securities laws in their chosen province, if any.
Registrations are handled by provincial securities regulators and coordinated through the Canadian Securities Administrators (CSA) and the National Registration Database (NRD).
5. Comply with regulatory requirements
To start a hedge fund in Canada, hedge fund managers need to register the fund in the province or territory where it will operate. Check if your province follows a unified approach under the CSA.
6. Maintain ongoing reporting
Once registered, hedge fund managers must regularly report to their provincial regulators. Both the fund and its manager must follow federal and provincial laws that deal with financial crimes like money laundering and terrorist financing.
They also need to follow local rules that address insider trading and handling proxy votes. The same is true for managing conflicts of interest.
7. Develop a compliance program
As a registered firm or individual, you should implement a compliance framework that can include:
- Know Your Client (KYC) procedures: for identification purposes and to assess if potential clients meet suitability and thresholds to be considered as accredited investors
- Anti-Money Laundering (AML) Policies: for suspicious transaction reporting and ongoing monitoring
8. Raise money from qualified investors
Raising capital is an important step in how to start a hedge fund. To do this, a manager must be able to present the fund and its strategy in a way that appeals to potential investors. Check regularly if your province has already implemented a minimum capital requirement for registering a hedge fund.
You also have two options when marketing the fund: you can either issue a prospectus or choose not to. The hedge fund’s key elements like its structure and strategy are defined in the prospectus. Using one allows access to a wider range of investors but comes with stricter rules.
On the contrary, the manager gains more flexibility but can only offer the fund to certain investors without a prospectus.
9. Market the hedge fund
Marketing a hedge fund in Canada involves more than creating promotional materials. It must be done within strict regulatory boundaries and with a clear strategy to attract qualified investors.
Since hedge funds in Canada are usually offered under exemptions from prospectus requirements, marketing efforts must avoid public solicitation. Hedge funds are also private offerings. So, it’s vital to identify the target market.
As mentioned above, hedge funds in Canada are usually marketed to:
- accredited investors
- wealthy individuals
- family offices
- institutions
Your outreach must focus on these groups, either directly or through exempt market dealers, investment advisors, or wealth managers.
Any marketing materials must be factual, balanced, and not misleading. These documents should highlight your:
- investment strategy
- risk management approach
- performance (if applicable)
- background of the management team
Avoid making exaggerations, especially projections or guaranteed returns.
Relationship-based marketing
Using relationship-based marketing can also be beneficial. For instance, you can try networking at industry conferences or do one-on-one meetings with allocators. Another way is to promote educational events for potential investors.
Be sure that the content is informational, not promotional, and targeted to the right audience.
10. Launch with a good seed capital
Most hedge funds launch with several million dollars in seed capital, although there is no legal minimum. Larger amounts help cover operating costs. It can also improve scalability.
Starting a hedge fund: Is it legal or not?
Starting a hedge fund is legal in Canada. Existing hedge funds operate under provincial and territorial securities laws. They are considered alternative investment funds and as mentioned above, they are usually offered to accredited investors. A hedge fund pools money from investors and invests in a wide range of assets. These can include:
- stocks
- bonds
- currencies
- derivatives
- private investments
Hedge funds are known for using active strategies. Their purpose is to seek returns that are not tied to traditional market benchmarks. The goal is usually to produce positive returns in all market conditions, although results can vary.
What is a hedge fund manager?
A hedge fund manager is a financial professional who manages hedge funds. Unlike traditional funds, hedge funds follow complex and flexible strategies designed to generate returns in all market conditions.
Hedge fund managers aim to produce positive returns regardless of whether markets are rising or falling. To do this, they rely on extensive market research and advanced financial analysis. They actively adjust fund holdings to respond to fluctuating market conditions. Their game plan is based on risk assessments and economic signals to protect the fund and find new opportunities.
As for a hedge fund manager’s compensation, it usually includes a management fee and a performance fee. This structure ties their earnings to how well the fund performs, aligning their interests with those of the client. To be successful, hedge fund managers need extensive financial knowledge and analytical skills. They should also be confident in managing risk and have practical experience in doing so.
Check out this video and listen to valuable insights from a Canadian hedge fund manager:
Like mutual funds and exchange-traded funds (ETFs), a hedge fund is a pooled investment vehicle. Learn about other types of investment vehicles in this article.
What is a fund manager?
A fund manager is responsible for overseeing an investment fund’s strategy and performance. This can include mutual funds or hedge funds. Fund managers can be individuals or part of a team, and their goal depends on the type of fund. For example, some aim to maximize returns, while others focus on reducing risk.
They base investment decisions on research and analyze market trends. If deemed needed, fund managers will also monitor economic signals and review a company’s financial profile to determine the best course of action.
Good communication and decision-making skills are common traits of an efficient fund manager. They can reach out to clients to explain the fund’s strategy and provide updates on performance.
What’s the difference between the two?
As mentioned above, a hedge fund manager is a specific type of fund manager who oversees hedge funds. While both roles involve managing investments, hedge fund managers use riskier and aggressive strategies than fund managers.
All hedge fund managers are fund managers, but not all fund managers run hedge funds.
How to start a hedge fund: Challenging but worthwhile
Starting a hedge fund in Canada is not a walk in the park. However, it can be a viable path for those who want to expand their services and manage capital for accredited investors. It can also provide career growth and personal satisfaction.
If you are serious about offering clients something beyond traditional funds, a hedge fund can help you do that. Indeed, it’s not a simple process, but it can be worth it for financial advisors who are up for the challenge.
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