Forex Trader to Forex Fund Manager: Starting a Forex Fund

Starting a forex fund to protect and manage your assets and the assets of others makes more sense than ever. Small forex funds attract the working wealthy and small businesses looking for safety and superior returns.

 

How do I set up a forex fund?

Setting up a forex fund means hiring a lawyer with the proper expertise to prepare all of the required documents and provide you with tax and regulatory advice. It's not as complicated as it may seem. To start a forex fund you need two companies: the forex fund and its investment manager. In the United States, the forex fund is a limited partnership unless multiple share classes are needed, in which case the forex fund could be a limited liability company (LLC). The forex fund manager is typically set up as a LLC.

 

Best Countries for Forex Fund Startups

The two best countries for startup forex funds are the United States and the British Virgin Islands. These countries offer the best laws and access to legal, tax, accounting, capital market and regulatory services. There are many other areas of the world that are considered primary offshore financial centers, but they are not practical for small forex funds. The good news is that you can set up a forex fund in any country without visiting it and your investors are not as concerned as you might think, with where the forex fund is located. 

 

Master Feeder Forex Funds

Feeder forex funds invest fund assets in a master forex fund that has the same investment strategy as the home country feeder fund. If you expect to have U.S. investors, the master-feeder forex fund structure requires a U.S. limited partnership as the feeder forex fund for U.S. taxable investors and a foreign corporation as the offshore feeder forex fund for foreign investors and U.S. tax-exempt investors.  The master forex fund, structured as an offshore corporation, should file a Form 8832 with the Internal Revenue Service (e.g., a check-the-box election allowing the master forex fund to be treated as a partnership for U.S. tax purposes) before engaging in trading activity on behalf of the feeder forex funds.

 

Offshore Forex Funds

U.S. based fund managers, with potential investors outside the United States and U.S. tax-exempt investors, should form offshore forex funds.  Under U.S. laws, a tax-exempt investor (such as an IRA, an ERISA-type retirement plan, a foundation, or an endowment) is liable for tax on unrelated business taxable income (UBTI) notwithstanding its tax-exempt status. UBTI exposure exists when a U.S. tax-exempt investor invests in a fund that trades on margin. Offshore funds allow these clients to avoid UBTI.

 

Forex Fund Fees

Most forex funds are quite small and many who start forex funds also keep their “day jobs.” Whatever the size, one real advantage to starting a fund is that the fund manager can legally accept compensation for his services. This compensation may provide a good supplement to the manager’s other income or it may allow him to manage the fund on a full-time basis.

Forex fund managers typically demand management fees of 1% to 2% of assets under management (AUM), as well as performance fees of 20% to 50% of net trading gains. Performance is calculated on a cumulative basis against a high-water mark so that performance fees are not paid out (or are reduced) until the losses are recouped.

If you had $100,000 AUM, a 1% management fee and a 20% performance fee, you would have combined fee income of  $7,000 from a $1,000 management fee ($100,000 x 1%) and (assuming fund performance of 30%) performance fee income of $6,000 ($100,000 AUM x 30% performance=$30,000 x 20%). If you had $1 million under management, you would have combined fee income of $70,000. If you had $1 billion AUM, you would have $50 million in combined fees, assuming fund performance of 20%.

 

Offering Documents

Offering Documents are the key to forex fund sales. The fund's offering materials and legal documents must clearly spell out the manager's approach to charging fees.

 

U.S. Licensing

If your forex fund will trade in futures contracts, commodity options (including options on futures contracts), leverage contracts involving certain precious metals, or futures contacts and commodity options traded on a board of trade, foreign futures and foreign options, your forex fund is a commodity pool. A commodities pool operator (CPO) and his forex fund are regulated by the Commodity Futures Trading Commission (CFTC) and it’s self regulatory organization, the National Futures Association (NFA). Unless you operate an exempt commodity pool, your offering documents (e.g., disclosure documents) must be approved by the National Futures Association (NFA).

 

Incubator Forex Funds

There is an alternative for forex fund startups if you do not yet have the track record necessary to attract new investors. Setting up an incubator forex fund allows you to develop a track record which will assist in attracting investors later in time.  An incubator forex fund is created by breaking down the fund development process into two stages. The first stage sets up the forex fund and investment manager. Completion of the first stage allows you to trade and develop a performance record using seed capital. In the second stage, your offering documents are developed and your performance record is audited and included in the PPM circulated to prospective investors. Starting out with an incubator fund affords the opportunity for those with a skill for trading, to break down the fund development process into a manageable undertaking. Some fund managers incubate their fund by managing their own money for 6-12 months within a limited partnership to establish a marketable track record. You can also use past performance of another account or back tested results to market the fund in some cases.

 

Forex Fund Administration

Many clients are accustomed to being a one-person business, trading from their home office. They are interested in trading for others to leverage their knowledge and make more money, but they don't want to change how they work. You do not need to hire an administrator to start a small fund, although it is a good idea if you do not have time to deal with fund accounting. Administrators provide fund accounting services, including net asset calculations, fee calculations and general administrative support. Capital Management Services Group offers these administrative services to help ensure your success.

 

Finding Investors

There are many investors who would be interested in investing in a forex fund if they had the opportunity. A trader may find that in addition to family and close friends, many colleagues and casual acquaintances may be potential investors. If you are interested in getting investors for your fund, your selling efforts must be personally directed toward investors who are known to you. A forex fund investor needs to be a sophisticated investor who understands the risks associated with the fund. The forex fund can have a web site, but cannot use it to find investors, as advertising and any other non-personal communications are prohibited. After you have established a track record, you can attempt to raise money from professional investors.

 

Legal Development Process

The legal development process is one that requires careful planning. A variety of regulatory issues intersect concurrently when developing a forex fund: tax, registration, entity type and classification, jurisdiction, security type, and so on. The wisest course of action for those thinking about developing a forex fund is to consult with qualified legal counsel before taking definitive steps. The legal development process normally begins with a planning consultation with a hedge fund attorney experienced in forming forex funds. This is where important determinations such as registration, jurisdiction choice, and utilization of safe harbors are made.

The whole process can be done in as little as 30 days at a cost of around $10,000 and in some cases, the cost is even less.

 

In Summary

The forex fund is an ideal vehicle to pool the resources of a small group of investors. The desire to pool assets in a way that is proper, both from a business and legal standpoint, has led many forex traders to start their own forex funds. For a successful forex trader, a forex fund is an efficient, legal, and professional way to trade your own money along with the money of those who want to benefit from your expertise.

---