For a few years now, I’ve been trading FX with an unorthodox quantitative model that has produced good results. The time has come to make it work for others. In the past, I vowed never to trade other people’s money. In the past, I’ve said some very stupid things. It’s time to move forward.
So what will it take?
Courage. Leaving my old life behind (and not “playing it safe”) is a little scary. Managing a business that has complicated and exacting compliance rules, and accepting the risks inherent in taking on clients is scarier. Courage is comparatively easy when I have the odds on my side.
Results. There are, surprisingly, only a few important measures of what makes a good model to a prospective investor. The major components of our decision about whether to invest or not are confined to just a few simple questions. What is our expected return each year? What is our risk? Are we gonna get ripped off? This part is easy, too.
Fairness. I realize the industry standard is a 2% management fee and a 20% performance fee. Some of the bigger players charge more. Some less. Would I, as a client, be happy to pay someone a 2% management fee up front and a 20% performance fee if I made the minimum annual target of 18% on my money? As an investor, what would I actually see in my account at the end of the year?
Clients. Obviously, I can’t achieve my goals without them. Results and fairness are great, but that doesn’t mean I can just sit back and watch the clients roll in. Finding willing investors for a currency fund is already difficult, thanks in large part to all the scumbags out there who lie about their results and steal from others. Outsourcing much of the relational sales effort will make things a little easier, but that must be managed as well. Imagine paying someone to bring in clients, only to have those clients be on a government watch list. Yikes! The other potential problem is acquiring clients who are not a good fit. Having people call me at odd hours to complain about a 1% move against them is not my idea of fun. Can’t they see that I have work to do? :)
As a former client, I’ve been burned pretty badly. One trader was an outright fraud. Fortunately, I dissolved the Power of Attorney before he could take a single trade. The other, a popular Twitter and StockTwits personality, was completely negligent in following his own risk management rules. While I was away in Afghanistan, he lost 70% of my account to margin calls in just a few days. With no explanation. I say this because I understand that people have concerns. I was stupid and learned the hard way.
I spoke to several people affiliated with the industry about how to approach this. Two stood out. An acquaintance of mine who is an experienced fund manager said I had to hit just three wickets.
1. A track record of at least 8%-12% per year for the last three years, accompanied by a maximum continuous drawdown of no more than 10%.
2. Invest $100K minimum of own capital, to prove that I can keep my head when the risk is on and the inevitable drawdowns occur. I should trade this sum for at least one year and hit my targets. If I can scrape up $500K from friends and family, all the better.
3. These returns must be audited by an independent agency, such as Futures Truth.
An introducing broker and placement agent for people like me said essentially the same thing. After we talked about compensation, he added that underselling myself would send the wrong message. It might also be a disincentive to placement agents, who typically take 20% of the fund manager’s performance fee. If an agent is earning 20% on peanuts, s/he won’t be around for long. Of course, this depends on the size of the placement.
As an example of my dilemma –
a. Initial investment: $100K
b. Management fee at 2%: $2K
c. Initial trading balance (a-b): $98,000
d. Annual return at 18%: $17.6K
e. Performance fee at 20%: $3.5K
f. Net return (d-e): $14.1K
g. Net return after taxes (@ 33%): $9.5K
g. Percentages -
On initial balance: 14.4%
On initial investment: 14.1%
After taxes: 9.5%
Whether $100K or $10M, I could go either way as a potential investor. As a manager, why would it be a good deal for my clients? Getting compensation right the first time around is critical and I’ll need to carefully structure something that is mutually rewarding.
(Not very scientific) food for thought.