FOREX TRADERS

[Ataglance2]

How to set up a hedge fund

1 Chose a name

A posh part of London or New York can be suitable, as in Pershing Square Capital, Cheyne Capital and Thames River Capital.

Or you could choose something slightly aggressive such as Tiger Capital, Citadel Capital or Centaurus. Among the big financial firms, it is voguish to squeeze as many meaningless words as possible into the title of a hedge fund. Length is not a sign of quality, however; a Bear Stearns hedge fund which went from $642m to zero was called the "high-grade structured credit strategies enhanced leverage fund".

2 Get a brass plaque in the Cayman Islands

Nearly all hedge funds are legally registered in tax havens to avoid both the taxman and to skirt regulatory hurdles - the sunny climes of the Caymans and Bermuda are particularly popular. Theoretically, a fund registered in London would have to register with the Financial Services Authority, but this has never actually happened. An FSA spokeswoman says: "Nobody ever registers hedge funds in the UK. If somebody did, we'd be scratching our heads over how to deal with it. We'd have to devise something."

3 Set your fees

The real fun starts here. Hedge funds are enormously lucrative - their standard fee arrangement is "two and 20". This means that as a fund manager, you can take 2% of clients' money up front before you do anything, then keep 20% of any appreciation on the value of your fund. For successful hedgies, that means a phenomenal payday. For example, if a fund raises $1bn from investors and achieves a 30% rise in value over a year, the fund's management earns $78.8m. Crispin Odey - one of London's leading hedge fund managers - has just paid himself £28m after his firm successfully negotiated the credit crunch to make more than £55m profit in the past financial year. Most of the remaining £27m will be shared among Odey Asset Management's 11 other partners. The fund manages around £2.7bn of assets. London's top hedge fund duo - Noam Gottesman and Pierre Lagrange of GLG Partners - each took home $350m in 2007, according to Alpha Magazine, an industry publication. Gottesman recently sold his six-storey townhouse in London's Mayfair to steel magnate Lakshmi Mittal for £117m. When asked the secret of his success, he once replied "paranoia".

4 Raise some money

This is the tricky bit. You will need £50m at the very least to have any kind of credibility. It helps if you have private wealth or rich, trusting friends. In Britain, hedge funds are not allowed to advertise directly to the public so much of the fund-raising is done behind closed doors through contacts, conferences and presentations. Good relations with City and Wall Street banks are essential - in return for brokerage business, firms such as Goldman Sachs and Morgan Stanley will often arrange introductions for hedge funds to potential investors. It is wise to accept money only from extremely well-off people. The last thing you want is to have clients pestering you every day because their entire savings are tied up in your fund. In the US, only individuals with assets of $1m or an annual income of more than $200,000 are allowed to invest in hedge funds.

5 Rent an office

Mayfair is a good spot. It's handy for a lunchtime plate of yellowtail tuna at Nobu. Rents can be as high as £90 per sq ft, compared with an average of £65 in the Square Mile, which means premises of 2,000ft for a fledgling fund will cost £180,000 per year. Joshua Gilbery, a commercial property consultant, says hedgies want "class A" premises with raised floors, suspended ceilings, a concierge and acres of space. "There might be only four or five chaps in a hedge fund office but they have so much money that it doesn't make much difference. These guys will have big, huge desks and lots of screens." Greenwich, Connecticut, has become a global hedge fund capital - it is home to more than 380 firms. The wealthier hedgies live in sprawling palaces with ice rinks, private cinemas and ballrooms and some commute by speedboat. Mike Tedesco, a local estate agent, can find you something top-class for $150 per sq ft, more than twice the typical Manhattan rent of $60 to $65.

6 Recruit some staff

Fund managers should be easy to find given the number of people recently laid off by Bear Stearns, Citigroup, Merrill Lynch and other banks suffering fallout from the global credit crunch. One pin-striped banker in New York has even taken to wandering around with a sandwich board declaring "experienced MIT graduate available for hire". Your back office and accounting functions can be contracted out to the many firms specialising in servicing the hedge fund industry. Scott Epstein, US head of HSBC's alternative fund services arm, says his staff can do your book-keeping, maintain your shareholder register, send out monthly statements to investors and do any regulatory paperwork. But you will have to be vetted first. "When we look at clients, we go through a very, very robust process of due diligence," says Epstein. "It's very much establishing a relationship with a counterparty - both parties want to be confident it's going to be comfortable mutually."

7 Choose an approach

Do you want to be a "quant" or a fundamental? The most hi-tech operators on the block are quantitative funds, which use highly complex software to trade at lightning speed. Buying and selling by the second, their programs
pick up trends in prices that are often imperceptible to the naked eye. Their software will process variables such as companies' earnings ratios and price history to determine what to buy - or they might pounce on tiny discrepancies between the price of the same stock on different stockmarkets. The downside is that when the market takes a knock, the quants' machine-driven trading can cause chaos. Last year, one Goldman Sachs fund lost a third of its value in a week - a drop of $1.8bn - as a "herd mentality" prompted scores of quant programs to dump stocks simultaneously. More traditional-style funds with a "fundamental" approach spend time researching the prospects of companies, currencies and commodities. They might take the time to talk to analysts, meet corporate management and attend shareholders' meetings.

8 Adopt a strategy

The classic hedge fund is called a "long/short", which means it takes straightforward positions to bet on different shares going either up or down. In addition to buying shares that you think will rise, you can "short" those you expect to fall. This is done by borrowing shares from a broker and selling them on the open market, in the expectation that you will be able to buy them back for a lower price and return them to the owner, pocketing a tidy profit on the way. During an FSA clampdown this summer on traders, Odey Asset Management was outed as one of several funds shorting shares in the troubled Bradford & Bingley. Other strategies are more sophisticated. A "convertible arbitrage" fund finds and exploits discrepancies in pricing. A "distressed debt" approach involves high-risk dealing in struggling companies, while a "global macro" fund bases its decisions on broader economic calls. An "event driven" strategy means watching the news carefully - after an air crash, for example, these funds might short airline stocks and in the aftermath of the 2004 tsunami, some attempted to invest in Sri Lankan construction firms.

9 Accessorise

As the money rolls in, it is a good idea to install quirky diversions to make sure your big-brained staff don't get restless and leave. One American fund, Pequot, boasts a basketball court beside its trading floor. Aquariums,
waterfalls, pinball machines and games rooms are useful symbols of quirkiness and success. Art is an obvious way to spend all your profits. One of the world's top hedgies, SAC Capital founder Stevie Cohen, has amassed a
collection which includes works by Van Gogh, Gauguin, Warhol, Lichtenstein, Manet and Jackson Pollock - not to mention Damien Hirst's shark pickled in formaldehyde.

10 Hope for the best

It could, of course, all go horribly wrong. Although 1,152 new funds opened for business last year, Hedge Fund Research reckons that 563 funds shut down. As many as one in five funds fail within their first year. And the strain can be telling - therapists in New York reported an increase of 25% in enquiries from distraught Wall Street workers towards the end of last year as the markets went crazy.