Hedging 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 hedging as well as how to start a hedge fund.
The basic formula for determining the hedge ratio, especially in equity or currency hedging, is:
Here is a sample scenario where hedging is used as a strategy. Let’s say an investment manager holds a portfolio of US stocks. To protect against fluctuations in the USD/CAD exchange rate, the manager enters into a currency forward contract to lock in the current exchange rate.
This action is an example of hedging because it reduces the risk that currency movements will negatively impact the portfolio’s value in Canadian dollars.
Here are some that should be avoided:
A forward contract is a private agreement to buy or sell an asset at a predetermined price on a specific future date. It is commonly used to hedge currency or commodity price risk.
Options give the holder the right, but not the obligation, to buy or sell an asset at a set price before a certain date. They are often used to hedge equity or commodity positions.
Futures are standardized contracts traded on exchanges to buy or sell assets at a future date and price. They are widely used to hedge:
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:
Let's discuss each step below:
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:
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:
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.
Before starting a hedge fund, it’s best if you have:
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) designation will likely thrive as hedge fund managers.
Most hedge funds are structured as limited partnerships (LPs) or trusts. A hedge fund structure usually includes:
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.
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.
Registrations are handled by provincial securities regulators and coordinated through the Canadian Securities Administrators (CSA) and the National Registration Database (NRD).
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.
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.
As a registered firm or individual, you should implement a compliance framework that can include:
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.
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:
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:
Avoid making exaggerations, especially projections or guaranteed returns.
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.
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.
Hedging as a strategy 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.
Want to read related content about hedging? Scroll down for more!
'It will be wrong to jump off the party too early,' warns PM Joseph Zhang
Job cuts, tech valuations are among the catalysts for rising concern
Q3 net income was $2.5 billion vs. a consensus for $1.4 billion
Investors are locking in 4% yields for 10 years as a safety play
Stocks now make up nearly 32% of foreigners' allocations to US assets
Investors snap up US stocks, bonds along with protective derivatives
Nasdaq 100 Index has risen each day but one in September
BofA says the S&P500 is more likely than not to drop in September
ETF expert and financial advisor outline why ETF and other fund issuers like to say they’re ‘first’ with a new strategy
Diversified strategy leads to steady returns, robust liquidity for retirement plan
