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A Guide to Starting Your Hedge Fund


Successful Hedge Fund Investing Begins with a Well-Informed Strategy

The hedge fund industry recently breached the 3 trillion dollar mark, exceeding the peak asset levels seen before the financial crisis. Until now, no resource was available that offered a strategy for launching, operating, and investing in hedge funds with a focus on the ever-growing energy commodity markets.

From hedge fund and energy industry experts, Erik Serrano Berntsen and John Thompson, comes a practical and comprehensive guide for both managers and investors. Managers will find it useful when thinking about the design and launch of their own hedge fund in the dynamic energy commodity field. A Guide to Starting Your Hedge Fund also gives investors a definitive resource to a proven process for evaluating the various energy commodity markets as potential hedge fund investments.

A Guide to Starting Your Hedge Fund shows how hedge funds and their underlying markets are structured, the opportunities for investment available, and the risks to avoid. Practical and comprehensive, the text contains an approach for developing a well-informed investment strategy as well as information on how to conduct thorough due diligence. Serrano Berntsen and Thompson include an examination of the practical aspects of operations and infrastructure, as well as fundraising, legal, and tax implications of creating a fund.

Written as an accessible guide, A Guide to Starting Your Hedge Fund is filled with the information and guidance needed to help launch a fund or invest in an energy commodity hedge fund that can become an institutional quality asset.

Erik Serrano Berntsen is CEO of Stable Asset Management. Prior to Stable, he was a Consultant with Bain & Co., where he consulted on private equity deal studies as well as a broad spectrum of corporate engagements. During his time at Bain he was also an advisor to the Prince's Trust, including advising on the UK-wide Volunteer Strategy initiative. Erik holds a Bachelor of Arts in Politics, Philosophy and Economics from Keble College, University of Oxford, and a Masters of Business Administration with honours and a Concentration in Finance from the University of Chicago Booth School of Business.

John Thompson is Principal of Stable Asset Management. Prior to Stable, he was a senior executive of Enron Europe. He has held regulatory affairs and market operations management roles with Wintershall (BASF) and was regional financial coordinator for Milestone Petroleum (Burlington Resources). John began his energy career in the oil and gas fields of the Rocky Mountains and later as a well-site mud-logging engineer. John has held several Directorships, including Member of the Supervisory Board of the European Energy Exchange (EEX). John also holds a Masters of Business Administration from the University of Chicago Booth School of Business.

Stable Asset Management is a hedge fund seeding firm that backs top trading talent globally to build institutional quality asset management firms.

Acknowledgements ix

PART I Why This Book? 1

Chapter 1 Introduction 3

Why This Book? 3

The Big Picture and Energy Commodities 4

Case Study: Amaranth Advisors 5

Layout 6

The Beginning 7

Bibliography 7

PART II The Basics 9

Chapter 2 What Is a Hedge Fund? 11

I Already Know What a Hedge Fund Is 11

A Little Bit of History 12

So What Is a Hedge Fund? 13

Hedge Funds (Un)Defined 16

The Growth of the Hedge Fund Industry 18

Hedge Fund + Commodities = Commodities Corporation 19

Whither Energy and Commodity Hedge Funds? 20

Moving Forward 20

Bibliography 21

Chapter 3 What Are Energy Commodities? 23

Introduction 23

What Are Energy Commodities? 23

The Regionality of Electricity 25

Why Are Energy Commodities Attractive for Investors? 27

A Complex, Solvable Problem 30

Drivers of Complexity 31

Conditions for Solvability 36

Principal Sources of Opportunity and Risk 39

Bibliography 46

Chapter 4 Trading and Investing in Energy Commodities 47

Bottom-up and Top-down 48

Trading + Managing a Business = Successful Hedge Fund 49

The Edge? 50

Trading Energy Commodities 52

Basic Financial Knowledge for Commodities 55

Conclusion 56

Bibliography 59

Part III Starting the Journey 61

Chapter 5 The Business Plan: Implications and Applications 63

Introduction 63

Objectives and Uses of a Hedge Fund Business Plan 64

Conclusion 71

Bibliography 72

Chapter 6 Laws, Contracts, and Lawyers 73

Don’t Kill Your Lawyer 73

Legal Basics for Funds 74

Master-Feeder Fund Structures 77

Side-Pocket Structures 81

The Firm 84

The Investment Advisory Agreement 86

Management Enterprise 87

Structural Design Decisions 88

Case Study: Complex Tax Structuring 98

Be Nice To Your Lawyer 103

Bibliography 104

Chapter 7 Service Providers 105

Introduction 105

Long-Term Relationship: Service Providers and Marriage 106

Service Providers: Who and Where? 107

Negotiate, Negotiate, Negotiate 108

Service? 110

How to Choose? 112

Final Thoughts 113

Bibliography 113

PART IV Running the Business 115

Chapter 8 Fundraising 117

Strategic Investor Portfolio Design 118

Start-up Lifecycle Analysis and Investor

Portfolio Development 127

Investor Acquisition - Marketing 130

Tools for Marketing and Key Marketing Documents 140

Marketing Documentation 143

Investor Maintenance - Investor Relations 152

Chapter 9 Operations and Infrastructure 155

Introduction 155

Infrastructure and Technology 158

Bibliography 160

PART V Final Thoughts 161

Chapter 10 Investing in Energy Commodity Hedge Funds 163

Asset Allocation: Portfolio Building Basics 163

Asset Allocation: Understanding Different Strategies 167

Checklist for Investing in Energy Commodity

Hedge Funds 170

Bibliography 171

Chapter 11 Quo Vadis 173

Bibliography 179

Appendix A Sample Business Plan Outline 181

Appendix B Outline of a Confidential Explanatory Memorandum: Sample Offshore Feeder Ltd 183

Appendix C Sample Due Diligence Questionnaire Outline 189

Index 195