Setting Up of A New Quantitative Finance Firm: Business Plan, Market Driver, Capital Raising and Ethics

Setting up of a New Quantitative Finance Firm:
Business Plan, Market Driver, Capital Raising and Ethics
Author
Konstantinos Moraitis
Supervisor
Ritabrata Bhattacharyya
WorldQuant University
February 2018
Electronic copy available at: https://ssrn.com/abstract=3202251

“Disclaimer: This paper was created as part of a WorldQuant University degree program
towards an MSc in Financial Engineering. This paper is reproduced with the consent and
permission of WorldQuant University. All rights reserved.”

Abstract
The process of setting up a new and successful hedge fund is an extremely complicated
and multifaceted procedure, as many different and closely-related parameters have to be taken
into account. Establishing a successful business plan, identifying market demand and
opportunities, raising capital, and embedding a predetermined code of ethics into the core values
of the firm are only but a few of the main challenges need to be addressed. In this project, we
will discuss about the establishment of a fully automated artificially intelligent hedge fund, called
Flow Capital Management or simply FCM. We will provide a detailed description of an innovative
business plan and examine the market drivers that separate it from the rest of the industry. In
doing so, we will identify and analyze modern trading models and strategies in the context of
existing laws and regulatory requirements.
According to Don Steinbrugge from Agecroft partners, despite the many negative articles
about the hedge fund industry, hedge funds have reached an all-time high 5 quarters in a row,
and the industry assets are forecasted to grow by 5.5% over the next 12 months. The strong
competition led many managers to make investments in new technologies, such as artificial
intelligence, advanced quantitative analytics, as well as alternative data sources. In this thesis,
we will discuss how these new technologies can help FCM generate positive alpha returns and
increase the efficiency and accuracy of information analysis and trading execution. Special
emphasis will be given in analyzing the proprietary trading models and strategies of our hedge
fund. Finally, we will discuss about the fund structure and marketing plan of FCM and propose
ways to ‘lure’ seed investments in order to raise between $100 and $150 millions of investment
capital.

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The information in this document is confidential and is to be only read by authorized parties.
Please refer to the confidentiality agreement for further details. This business plan is not an
offering for securities.
Confidentiality Agreement
The undersigned reader acknowledges that the information provided in this business plan is
confidential; therefore, the reader agrees not to disclose it without the express written
permission of or an authorized agent of Flow Capital Management, Inc.
It is acknowledged by the reader that information furnished in this business plan is in all respects
confidential in nature, other than information which is in the public domain through other means
and that any disclosure or use of same by reader, and may cause serious harm or damage to
aforementioned parties.
This business plan is not to be copied or reproduced by any means without the sole written
consent of an authorized agent of Flow Capital Management, Inc.
Upon request, this document is to be immediately returned.
__________________________________ _______________
Signature Date
_______________________________
Name (typed or printed)

Table of Contents
1 The Hedge Fund Industry

1.1 Introduction …………………………………………………………………………………………………………..… 8
1.2 Actual on field Challenges ………………………………………………………………………………………… 9
1.3 Regulation and Compliance ……………………………………………………………………………………… 10
2 Structure Plan of the fund

2.1 Market Driver ………………………………………………………………………………………………………….. 10
2.2 Fund Launch Plan …………………………………………………………………………………………………….. 11
2.3 Our Team and Organization ……………………………………………………………………………………… 14
2.4 Target Market ………………………………………………………………………………………………………….. 14
3 Investment Allocation Strategies

3.1 Main Strategy of the fund …………………………………………………………………………………….….. 15
3.1.1 Long/Short Equity Strategy ………………………………………………………………………………..15
3.2 Other Strategies
3.2.1 Quantitative – Black Box Strategy ……………………………………………………………………… 16
3.2.2 Even Driven Strategy …………………………………………………………………………………………. 16
3.2.3 Relative Value Arbitrage Strategy …………………………………………………………….………….16
3.2.4 Investments in Cryptocurrencies ………………………………………………………………………. 17
3.2.4.1 Current Regulation in Cryptocurrencies ……………………………………………………………17
4 Long-Term Survival of the fund and Expansion Plan

4.1 Long-Term Survival Strategies …………………………………………………………………………………. 19
4.2 Expansion plan to BRICs ……………………………………………………………………………………..…….20
5 Trading Models and Strategies of the fund

5.1 Efficient Market Hypothesis (EMH) …………………………………………………………………………… 20
5.2 Hybrid Machine Learning Trading Models ………………………………………………………………… 21
5.3 Fully automated AI trading systems …………………………………..………………………………………22
6 Risk Management Strategies

6.1 Advanced Risk control Systems …………………………………………………………………………………22
6.2 Models to handle market shocks ………………………………………………………………………….…… 23
6.3 Models to handle redemption pressure ……………………………………………………………………. 24

7 Business Plan
7.1 Selecting Legal Counsel ………………………………………………………………..………………………….. 25
7.2 Fund Offering and SEC requirements ………………………………………………………………………… 25
7.3 Fund Name …………………………………………………………….………………………………………………… 26
7.4 Formation of the Fund …………………………………………………………………………………………….. 26
7.5 Prime Broker and Custodian Services …………………………………………………………………….… 28
8 Ethics and Marketing Philosophy

8.1 Culture and Ethics ………………………………………………………………………………………….………… 29
8.2 General Marketing Philosophy …………………………………………………..…………………….……… 30
8.3 Detailed Marketing Plan ………………………………………………………………………………….………. 31
9 Capital Raising
9.1 General Capital Raising Plan ……………………………………………………….……….……………..…… 32
9.2 Exact cost model and Projected Revenue ………………………………………….…..…………….……32
9.3 Exit Strategy ………………………………………….………………………………………….….………….….…. 35
9.4 Breakeven Analysis ………………………………………….……………………………………….….…………. 35

1. The Hedge Fund industry
1.1 Introduction
The hedge fund industry is extremely competitive with over 900 out of 1,000 new funds
launching every year to be liquidated annually, as the majority of them can’t justify the high fees
due to poor performance. It is expected that the closure rate will continue to rise for small and
mid-sized hedge funds as a result of high expenses, small revenues of their businesses and lack
of innovation. It is evident that strategies which used to work well in the past, like traditional
long/short equity focusing on the developed markets, are no longer offering the alpha generation
opportunities that historically drove their performance. On the other hand, new markets like Asia
and India, artificial intelligent trading strategies, reinsurance and higher turnover fixed income
strategies seem to be the future winners of the game.
The recent major shift in the regulatory landscape and significant changes in the investors’
preferences, signals growth in marketing of funds outside the U.S., which was avoided till now
due to complex legal and regulatory requirements enforced by foreign authorities. The
development of new products that identify and simplify the requirements of marketing in over
than 100 countries around the world, has made the expansion to new markets easier than ever.
There is also a major shift towards new technologies like machine learning, where artificial
intelligent systems can analyze large amounts of data at very high speeds and improve their
performance through such analysis.
For example, the New York company Rebellion Research, uses a form of machine learning
called Bayesian Networks in order to predict market trends and identify particular trades. It
seems that high connection speeds, measured in milliseconds or microseconds, and robust ultra-
low latency direct market access (ULLDMA) trading systems are the key elements to define
winners from losers. These are some of the areas that our research project will explore for
spotting the market drivers that will distingush our hedge fund from the rest of the competition.

1.2 Actual on field Challenges
Despite the significant growth in the hedge fund sector, banks are reluctant to do business
with hedge funds. It is true, that the process of setting up a new hedge fund is a pretty
complicated, complexed and risky procedure. With more than 90% of hedge funds closing down
during their first year of registration, it is clear that only the “fittest” and better adapted will
survive in the long-term. The key challenges that most of the new hedge funds face are without
a doubt banking, reporting, cyber security and increased regulations. Understanding the costs
and relative complexity of the sector when launching a start-up is crucial for its long-term survival
and overall success. Poor business planning, limited capital, and not well-prepared breakeven
analysis is the recipe of failure, especially in highly competitive sectors like finance.
It is clear that there is not a one size fits all strategy, and successful strategies of one fund
cannot easily or successfully be duplicated to another. Important details like understanding the
target investor, the tax consequences to the investor, and choosing the right service partners are
all crucial challenges that need to be addressed. In the last years there is a major shift in the way
investors are dealing with hedge funds, and it seems that the competition and demands are more
challenging than ever. It is by no coincidence that the average management charge fell from
1.45% in 2015 to 1.35% in 2016 according to EY. As one North American pension fund clearly
stated in an EY report, “Investors are demanding more and paying less. Adapt or loss out”. The
report stated clearly that the pressure on fees is not likely to let up, as there is an unprecedented
change on the appetite of investors.
Considering the fact that Rhode Island’s pension scheme pulled $585m it had invested in
seven hedge funds, it becomes obvious that the sector’s landscape changes dramatically. New
Jersey’s pension fund and the New York City Employees’ Retirement System also reduced their
exposure. The general dissatisfaction with the high fees needs to be addressed immediately.
Newer passive products incorporating cheaper fees and better liquidity, which can also mimic
the average hedge fund performance, start to take a significant portion out of the “hedge fund
pie”. Investors seek for more customizable products and better control over their assets. One of
the main selling points of FCM, will be reduced fees and better customizable, tailored to

investors’ needs products. Last but not least, enhanced liquidity and reduced lock-up periods to
the investors’ funds will strengthen our fund’s presence even more.
1.3 Regulation and Compliance

Regulation and compliance have become increasingly important in the process of
institutionalization of the hedge fund industry and a robust compliance system is absolutely
necessary in order to raise capital. The complexity and cost of various operational functions is
rapidly increasing, and the Securities and Exchange Commission and other regulatory bodies are
becoming less and less tolerant of even small misconducts. This industry shift is definitely positive
in terms of legitimization and investor protection. However, this shift creates a significant cost
problem and makes more difficult the entry of new funds, as the increase in compliance costs is
mainly being absorbed by the fund managers. At this point, hedge funds can not to pass these
extra expenses on to their investors. As of March 30, 2012, Title IV removed the SEC registration
exemption for private advisors, which means if someone advises a private fund the registration
exemption applies up to $150 million in AUM. This exemption falls under the Private Fund Advisor
exemption. Therefore, FCM would be exempt for federal SEC registration, and would only have
to consider registering in its state of operation, as the initial capital raise for the fund is between
$100 and $150 million.
2. Structure plan of the fund

2.1 Market Driver
According to market research firm Preqin, roughly 9 percent of all systematic funds managing
$197 billion in total, use specialized computer algorithms based on statistical models for placing
their trades. The problem with these funds, is that usually they don’t perform as well as the funds
operated by human portfolio managers. This obviously creates space for new automated trading
systems that can utilize more efficiently the new technologies, and thus generate better alpha
returns. The ultimate goal of our fund is to build a fully automated AI trading system, able to do
something no other human or machine is currently doing. For achieving this, we will use a new
system called “neuroevolution”, which uses evolutionary computation to build better deep
learning algorithms. This system will help significantly in the process of evolving the weights that
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operate on the deep learner. As Goertzel has correctly stated, “Finance is a domain where you
benefit not just from being smart, but from being smart in a different way from others."
2.2 Fund Launch Plan

According to eVestment, the global leader in institutional investor data and analytics, cities
with large concentrations of other funds might be the best places to consider for establishing a
new hedge fund. The reason for that, is simply the fact that these cities can provide a considerably
high network of people, as well as other significant resources. With New York and Chicago
topping the U.S. list, San Francisco seems to stand equally well, being third in terms of assets
under management. North America seems to have the largest concertation of hedge funds by
location, which justifies our choice to have a domicile in North America and initial offices in San
Francisco.
The main strategy of our fund will be a fully automated long/short equities trading strategy,
which simply involves buying equities that are expected to increase in value, and selling equities
that are expected to decrease in value. According to figures 3 and 5, the Long/Short Equities
strategy delivered the best results in 2017, and seems to be the most popular investment strategy
in San Francisco, attracting the interest of 67% of the total investors. In addition, some other
reasons we decided to set up our offices in San Francisco are:
1. There is a large talent pool of highly-specialized tech and quantitative professionals, thus
making it possible to build a highly-sophisticated top performing team. Indeed, with some
of the country's best schools nearby, the city provides a fresh crop of talent that is hard
to beat.
2. San Francisco is home to many prominent venture capital firms, incubators, as well as
angel investors, thus providing significant access to capital. In addition, in this area we can
find investors specifically interested in new technological endeavours, like the fully-
automated hedge fund we are trying to build.
3. The renowned tech community of the Bay area will increase our networking opportunities
and meetups, thus enabling us to be among the first to access any new artificial intelligent
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technologies or other top-notched knowledge, that can help us gain a competitive
advantage in the market.
4. With so many successful start-ups and like-minded individuals nearby, there is a very high
probability of fast progress for our fund.
5. Having the San Francisco area code can sometimes open many doors, making the fund
more appealing and thus attracting extra attention and capital.
6. Specialized investors are more willing to invest in companies that do not require them to
travel a lot in order to monitor and manage their investments and San Francisco offers
that.
7. There are several specialized service providers, such as lawyers and accountants with the
proper know-how in handling the mechanics of high-growth technological and financial
companies.
8. Finally, the presence of cutting edge technological and quantitative start-ups in this area,
makes it more attractive to people starting similar companies.
Figure 1. Top Cities by Hedge Fund Assets under management

Source: Preqin Hedge Fund Analyst
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Figure 2. San Francisco Based Hedge Funds by type
Figure 3. Strategy Preferences of San Francisco-Based Investors

Figure 4. Mean Terms and conditions of San Francisco-Based Hedge Funds vs. All Hedge Funds
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Figure 5. Best and Worst Strategies and Regions
Source: Eurekahedge
2.3 Our team and Organization
At the initial stages, Flow Capital Management will occupy a total of five people; one Senior
Portfolio Manager, one Head Trader, one Chief Operating Officer, one Investment Analyst, and
one Chief Marketing Officer/Administrator. One of the great benefits of working as an investor,
is the fact that we do not need to have large teams in order to make money. Many of the most
well-known hedge funds have far fewer employees than normal companies in the same revenue
range. By the time we get to around $300 millions in AUM, we will add a few more employees in
our team and make use of a variety of outsourced services, than can help us in various trading
and compliance tasks. Even when the hedge fund starts growing significantly, the number of
employees will remain relatively low, as special emphasis will be given to quality over quantity.
Table 11 represents a good estimation of the initial Budget Forecast of FCM.
2.4 Target Market

A Hedge fund is nothing more than an investment vehicle that high net-worth accredited
investors and well-established institutions use in order to pool cash or capital together and make
investments in various financial securities and other investment vehicles. These investments
require large initial capital to invest in and only high net-worth and accredited investors are able
to cash in on it. Hedge funds are only open to limited partners with the required cash for investing
in capital intensive business portfolios.
As a standard, licensed and accredited hedge fund firm, Flow Capital Management will offer
a wide range of investment portfolio management services. Our target market includes
businesses and investors that have the required capital to invest in our fund. Specifically, our
target market includes high-net worth individuals that have an aggregate income of over
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$300,000 or a net worth of at least one million dollars, as well as top corporate executives,
investment clubs, accredited investors and various corporate organizations and blue-chip
companies. We are coming into the industry with a range of innovative business and investment
strategies that will enable us to generate very good returns on our clients’ funds.
3. Investment Allocation Strategies

Hedge fund strategies include a wide range of risk tolerance, as well as investment strategies
within a broad array of instruments. For example, some of these instruments include equity and
debt securities, currencies, commodities, cryptocurrencies and derivatives. Investment decisions
are dependent on the fund’s strategy and level of liquidity. Below we describe the most
important hedge fund strategies that FCM will integrate.
3.1 Main Strategy of the fund

3.1.1 Long/Short Equity Strategy
The Long/Short Equity Strategy is one of the most commonly used strategies for startup
hedge funds. This equity strategy simply involves the process of buying and selling equity and
equity derivative securities. In general, funds that use a long/ short equity strategy employ a wide
range of qualitative, fundamental and quantitative techniques in order to make their investment
decisions. FCM will make investments primarily in publicly traded equities and derivatives and
will tend to be long biased and also have fairly straight investment fund terms. We will implement
an absolute return long/short (long biased) equity strategy, that systematically focuses on
specific value fundamentals and risk management controls, while at the same time takes
advantage of certain market anomalies that have thoroughly been back-tested over long periods
of time. In essence, this strategy could be structured with an initial fundamental value screen for
potential investments, and the fund could use a quantitatively driven approach to sort portfolios
based on factors that have been identified as critical in maximizing return and minimizing risk.
Finally, the incorporation of this strategy will provide more flexibility and better liquidity with
regards to lock-up periods.
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3.2 Other strategies
3.2.1 Quantitative – Black Box Strategy
FCM will make extensive use of automated AI black box strategies, relying on advanced
quantitative and computational analysis to make various investment decisions. These strategies
typically make use of technology-based algorithmic trading models in order to achieve the
desired investment objectives. Quantitative strategy funds are also known as “black box” funds,
since investors usually have limited access to investment strategy specifics.
3.2.2 Event-Driven Strategy

FCM will incorporate event-driven strategies in order to exploit the pricing inflation and
deflation that occurs in response to specific corporate events like mergers and takeovers,
liquidations, restructuring, reorganizations and spin-offs. FCM will use state of the art proprietary
fundamental modeling and analysis software for exploiting and timing properly these event-
driven strategies.
3.2.3 Relative Value Arbitrage Strategy

Relative value arbitrage or simply “pairs-trading”, is a strategy that takes advantage of
perceived price discrepancies between highly correlated investments, like stocks, commodities,
currencies and options. These strategies are highly risky and require extensive expertise in the
field as well as cutting edge technology. FCM’s high-tech profile and expertise in automated
trading technologies will clearly give us a strong competitive advantage in this space.
3.2.4 Investments in Cryptocurrencies

As a modern and high-tech hedge fund, FCM will also include cryptocurrencies in
its trading arsenal, and use them as a form of alternative investment, both for hedging and
profiting purposes. Most of the hedge funds linked to cryptocurrencies are relatively
new and have been launched in recent years, in order to capitalize on the rapid
expansion of this industry. In addition, as the digital currency landscape continues to
grow, more and more hedge funds will follow, provided that there are still available profits to be
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made. It is worth to notice that some hedge funds that recently started trading cryptocurrencies,
did exceptionally well in 2017, and according to a recent Blomberg report nine hedge funds that
linked to cryptocurrency investments rose by 1,167% as a group. Billionaire trader and long-time
“cryptocurrency bull” Mike Novogratz has also predicted that the total crypto market cap will
reach $2 trillion by the end of 2018, which justifies the decision of FCM to include
cryptocurrencies in its portfolio.
While most of the hedge funds and other top investors are still sceptical about the
cryptocurrency sector, those hedge funds which explored the expanding industry found that they
have access to more than just speculation over rising currency prices. In addition, the fact that
Goldman Sachs Group Inc. is setting up a trading desk to make markets in digital currencies such
as bitcoin, clearly shows that cryptocurrencies are here to stay. However, there is still big concern
about this form of investment as a cryptocurrency investor can literally lose all of his money if
the “bubble” eventually collapses. The Digital Currency Fund Atlanta, which gained nearly 1,500%
in 2017 after fees, warned its clients that they should only invest a tiny portion of their net worth
in cryptocurrencies. FCM will only invest a small portion of its clients’ funds in cryptocurrencies
in order to minimize any upcoming risks coming from this investment.
3.2.4.1 Current Regulation in Cryptocurrencies

It is true that cryptocurrencies are not yet properly regulated and thus, there is a significant
uncertainty and risk for anyone considering trading them. At the moment, cryptocurrency
exchanges are regulated as money-transmission services, with licenses granted on a state-by-
state basis. However, FCM sees a new trend in terms of regulation, as both the US Securities and
Exchange Commission (SEC) and the cryptocurrency industry advocates welcome a replacement
to this system. FCM will thoughtfully consider all regulations and guidance, laws, as well as the
relevant principles-based securities law framework, before advising clients in trading
cryptocurrencies.
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Monthly Sales Analysis - Revenue
Month 1 2 3 4 5 6 7 8 9 10 11 12
Long/Short Strategy $96,723 $96,830 $96,938 $97,045 $97,153 $97,260 $97,368 $97,475 $97,583 $97,690 $97,798 $97,905
Black Box Strategy $176,400 $176,596 $176,792 $176,988 $177,184 $177,380 $177,576 $177,772 $177,968 $178,164 $178,360 $178,556
Cryptocurrencies $14,612 $14,629 $14,645 $14,661 $14,677 $14,694 $14,710 $14,726 $14,742 $14,759 $14,775 $14,791
Event Driven $17,660 $19,426 $20,662 $22,958 $24,724 $26,313 $26,490 $27,285 $27,550 $28,521 $29,404 $30,199
Relative Value Strategy $17,385 $18,117 $19,215 $20,405 $23,699 $28,365 $29,280 $29,738 $30,470 $31,110 $31,842 $32,483
Totals $322,780 $325,598 $328,252 $332,057 $337,437 $344,012 $345,424 $346,996 $348,312 $350,244 $352,178 $353,933
Monthly Sales Analysis - Units

Month 1 2 3 4 5 6 7 8 9 10 11 12
Long/Short Strategy 900 901 902 903 904 905 906 907 908 909 910 911
Black Box Strategy 1800 1802 1804 1806 1808 1810 1812 1814 1816 1818 1820 1822
Cryptocurrencies 198 198.22 198.44 198.66 198.88 199.1 199.32 199.54 199.76 199.98 200.2 200.42
Event Driven 200 220 234 260 280 298 300 309 312 323 333 342
Relative Value Strategy 190 198 210 223 259 310 320 325 333 340 348 355
Totals 3289 3321.22 3351.44 3394.66 3454.88 3528.1 3544.32 3562.54 3577.76 3599.98 3622.2 3642.42
Monthly Sales Analysis - Cost of Sales

Month 1 2 3 4 5 6 7 8 9 10 11 12
Long/Short Strategy $3,123 $3,126 $3,130 $3,133 $3,137 $3,140 $3,144 $3,147 $3,151 $3,154 $3,158 $3,161
Black Box Strategy $5,400 $5,406 $5,412 $5,418 $5,424 $5,430 $5,436 $5,442 $5,448 $5,454 $5,460 $5,466
Cryptocurrencies $752 $753 $754 $755 $756 $757 $757 $758 $759 $760 $761 $762
Event Driven $860 $946 $1,006 $1,118 $1,204 $1,281 $1,290 $1,329 $1,342 $1,389 $1,432 $1,471
Relative Value Strategy $665 $693 $735 $781 $907 $1,085 $1,120 $1,138 $1,166 $1,190 $1,218 $1,243
Totals $10,800 $10,925 $11,037 $11,205 $11,427 $11,693 $11,747 $11,814 $11,865 $11,947 $12,028 $12,102
Monthly Sales Analysis - Gross Profit

Months 1 2 3 4 5 6 7 8 9 10 11 12
Totals $311,980 $314,673 $317,215 $320,852 $326,010 $332,319 $333,676 $335,182 $336,447 $338,297 $340,150 $341,831
Table 1. Monthly Sales
Monthly Sales (Units)
2000
1800
Numbers of Units
1600 Long/Short Strategy Black Box Strategy

1400
1200
1000 Cryptocurrencies Event Driven
800
600
400 Relative Value Strategy
200
0
1 2 3 4 5 6 7 8 9 10 11 12
Month
Figure 6. Monthly Sales (Units)
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Sales Revenue By Product
$200,000
$180,000
Dollars of Revenue
$160,000 Long/Short Strategy

$140,000 Black Box Strategy
$120,000
$100,000 Cryptocurrencies
$80,000
$60,000 Event Driven
$40,000 Rela tive Value Strategy
$20,000
$0
1 2 3 4 5 6 7 8 9 10 11 12
Month
Figure 7. Sales Revenue by Product
4 Long Term Survival of the Fund and Expansion Plan

4.1 Long-term Survival Strategies
Flow Capital Management will constantly monitor the concentration of funds invested in
associated strategy categories and manage risk properly, by ensuring that the fund is always
working to evolve its own strategy through new and innovative approaches. The main target of
FCM is to create value for its investors over the long-term, by avoiding performance eroding
behaviors, and maintaining the characteristics of a high performing fund for a longer period of
time. As FCM grows its assets under management, special attention will be given to the
relationship between growth and returns. Determining the optimal size is not an easy task, and
no specific formula exists to ensure that a fund operates at this theoretical point of maximum
efficiency.
Recent academic research has shown that emerging managers tend to add more value than
more established funds, which provides a strong competitive advantage to our company. In
addition, Aggarwal and Jorion (2008) found that performance fees have a greater incentive effect
on emerging managers as they are presumably starting with less wealth. In essence, this means
that the marginal utility of the same dollar amount of fees is progressively decreasing as the
manager gets richer. The incentive to perform may erode as the manager is able to collect large
management fees regardless of performance. To deal with this problem, FCM will constantly
introduce new talent of portfolio managers and traders to the fund and propose a much smaller
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management fee with higher performance-based compensation. According to the agency theory
proper incentives should encourage effort by managers, and under this structure wealth could
only grow through sustained performance.
4.2 Expansion plan to BRICS

As a multifaceted hedge fund, FCM will establish an aggressive expansion plan after the
successful completion of the initial capital raising period. Management will expand each sector
of the business by developing limited partnerships in countries like China and India that will
attract additional capital for the fund’s marketable securities and portfolios. FCM has set up an
expansion plan to increase its proportion in alternative investments after the third year of
operation, by investing in new emerging market vehicles in countries like China, Russia, Brazil and
India. Specifically, FCM will use a multi-pronged strategy of fixed income, equity long/short and
arbitrage. The fund will start out with an initial investment of $25 million in BRICs after the third
year of operation and there is a fundraising goal of $100 million. Despite the fact that Goldman
Sachs Group Inc. and some major hedge funds are getting out of the BRICs, FCM believes that
there are still significant opportunities in countries like India and China, and our fund can
capitalize on them.
5 Trading models and strategies of the fund

5.1 Efficient Market Hypothesis (EMH)
In finance, there is a well-known theory called Efficient Market Hypothesis (EMH), which
states that it is not possible to make any profits by predicting the stock market movements, as
the current stock prices always incorporate and absorb all new information. This theory claims
that the market is efficient and has self-correction mechanisms in incorporating all new
information in the stock prices, leaving no space for prediction. As discussed by Malkiel in 2007,
the market follows a “random walk”, and the past movement of a stock price cannot be used to
predict its future movement. However, Hsieh (1991) examined the daily returns of the S&P 500
index from 1983 until 1989 and found that the market returns are not following a “random walk”,
and thus can be predicted. Therefore, there is strong evidence against randomness in stock price
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movements, which means that our algorithmic trading models can be used without any problems
in predicting stock markets and generating alpha.
5.2 Hybrid Machine Learning Trading models

Hybrid machine learning systems are a combination of more than one algorithm or models,
with the ultimate goal of creating better performing and more reliable forecasting systems. The
hybrid machine learning system of our fund resembles to the one that Choudhry and Garg
created in 2008 for predicting the stock prices of the Indian Stock market. Choudhry and Garg
proposed a hybrid machine learning system based on a combination of Genetic Algorithms,
Support Vector Machines and technical analysis. Many technical indicators used as input features
in the GA algorithms in order to find correlations between different stocks.
As per Choudhry and Garg in 2008, “support vector machines (SVMs) are a type of maximum
margin classifier which seeks to find a maximum margin hyperplane called optimal separating
hyperplane to separate the classes “. The reason that SVMs included in the hybrid model has
mainly to do with the fact that they don’t face serious overfitting problems as other machine
learning methods, which translates to more accurate price predictions and better returns. The
final results of this research showed that the hybrid machine learning systems tend to
outperform the standalone traditional systems and improved the performance of the SVM
system significantly. FCM will make extensive use of hybrid machine learning models, which will
help the fund significantly in the alpha discovery process.
Figure 8. Structure of a proposed hybrid trading system

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5.3 Fully automated AI Trading systems
Flow Capital Management will make use of fully automated artificial intelligent systems
(trading bots), with zero human intervention. For this process, we will use advanced machine
learning techniques, combined with deep neural networks. The trading bots will incorporate
multiple forms of artificial intelligence, including genetic evolution and probabilistic logic. The
fully automated trading systems will make their own market predictions, and then “vote” of the
best course of action after analyzing a sequence of parameters. Some of these parameters will
include market prices, volumes, macroeconomic data and corporate accounting documents. A
deep reinforcement learning framework will be used as a solution to the portfolio management
problem. San Francisco startup Sentient Technologies has been trading in a similar way since
2015.
FCM will rely not only on machine learning and pattern recognition algorithms like the
majority of hedge funds, but also in self-taught neural procedures capable to locate and act on
new patterns never experienced in previous data. In addition, a pool of carefully selected
technical indicators combined with sentiment analysis, will improve the performance of our
trading models even more. Special attention will be given to continuous research of new
parameters and technological resources. This automated implementation, will reduce several
problems arising from psychological biases or emotions found in human traders, which usually
lead to wrong decisions and increased loses. Finally, the high importance of AI technologies in
the financial sector is also verified by the extensive use of artificial intelligent algorithms in major
data-centric hedge funds like Renaissance Technologies and Two Sigma.
6 Risk Management Strategies

6.1 Advanced Risk Control Systems
The process of managing portfolio risk is a rather complicated task and is probably the most
important factor we consider when evaluating the performance of a fund. FCM will provide
robust, reliable and advanced risk management strategies and algorithms, in order to maintain
an appropriate level of risk relative to the fund’s return expectations. Advanced risk management
22

controls reviewing industry, sector and geographic exposures will be utilized on a daily basis. Risk
management algorithms will check in real time various operational risks, changes in regulatory
environments, currency risks, as well as product demand risks.
VaR analysis through Monte Carlo simulations will be used as the first layer of the risk
management systems. Incremental VaR and other methodologies will help even further in the
process of getting a better picture of how individual positions affect the overall fund risk. The
systematic use of circuit-breakers like the emergency fail-safes used to prevent nuclear reactors
going haywire, will help FCM distinguish itself from the rest of the competition. These circuit-
breakers will trip when trading becomes erratic, and thus protect our clients’ funds from events
similar to the famous 2010 flash crash.
Flow Capital Management will implement strict risk management criteria, such that no one
stock can make up more than 5 percent of the overall portfolio investments. That way, the
idiosyncratic risk associated with each company is reduced to a reasonably small portion of the
fund. To strengthen our risk management controls, we will also perform thorough analysis of the
investment decisions processes, tactical trade reviews and profit and loss reviews for all portfolio
managers.
6.2 Models to handle market shocks

Market shocks often bring to light the problematic nature of the traditional models and
structure of the financial markets. The recent credit crisis of 2007 and the blow-up of LTCM in
the summer of 1998, made it clear than new strategies and models need to be considered in
order to handle these shocks. The incorporation of new models and strategies seems to be more
important than ever. As a new and innovative Hedge Fund, FCM will adopt new risk modelling
and asset diversification techniques for protecting investors’ funds from upcoming market
shocks. The nonlinear exposure of hedge funds, as well as sudden and structural breaks in the
systematic risk exposures cannot be measured properly by the traditional models. It is
well-known that techniques like the linear factor model, adjust exposures with a significant time
lag. To overcome this issue, FCM will make use of nonlinear and dynamic exposure models that
will help it reduce the fund’s losses during extreme market conditions.
23

In general, linear models based on asset class risk factors are more suitable for traditional
mutual funds than hedge funds. The beta exposure of hedge funds is non-stationary, as they react
in a dynamic way to changing market conditions which shifts the fund’s exposure profile.
Replication factor strategies (RFS), produce satisfactory results only for directional equity
exposure strategies. To deal with this significant issue, FCM will adopt a different risk
management approach by making use of neural net trading systems and applications of fuzzy
logic. This combination can generate great results in terms of trading performance and portfolio
management. The application of modern machine-learning techniques such as neural networks,
will improve significantly the pattern recognition and forecasting tasks. FCM will also adopt
better diversification strategies by investing in various alternative assets. Specifically,
investments in hard assets like oil and gold, which are negatively correlated with the performance
of stocks and bonds, will provide a very effective hedge against any upcoming market shocks.
6.3 Models to handle redemption pressure

Liquidity is another major factor affecting the performance of a hedge fund. Despite the fact
that during the financial crisis many investors faced serious liquidity issues as their funds were
frozen when the financial market crashed, “gates” with one-year capital lock ups continue to be
dominant in the market. “Investments and Pensions Europe” reports that long/short funds with
quarterly redemptions have generated cumulative returns of about 22% higher than long/short
funds in which investors had weekly access to capital. Thus, “investor-level gates” is a very
effective approach to handle redemption pressure. For example, King Street Capital
Management, one of the largest credit hedge firms with more than $19 billion in assets under
management, introduced an “investor-level gate” recently too.
The “investor-level gates” approach will provide an automatic redemption-smoothing
mechanism and will also offer a significant layer of protection from any future impulsive
redemption moves if financial markets experience severe adverse shocks again. During the
financial crisis of 2008, “fund-level gates” resulted in a redemption panic in the hedge fund
industry, as many investors tried to redeem ahead of other investors out of fear. The adoption
of the “investor-level gate” strategy will provide a different approach than “fund-level-gates”,
24

which limit redemptions to 25% of an investor’s money each quarter over four quarters. As a
result, the liquidity of our investors won’t depend on other investors in the fund, and will protect
institutional investors with more long-term investment horizons from being swept by “emotional
redemption waves”.
7 Business Plan
7.1 Selecting Legal Counsel
The first step before launching our start-up, should be to hire a legal counsel in order to
ensure proper execution of the registration requirements, document drafting, compliance and
other important discussions about the firm’s structure. FCM will hire Cole-Frieman & Mallon LLP
as its legal counsel. Cole-Frieman & Mallon LLP is a boutique law firm with an exclusive focus in
the investment management sector. The firm has a wealth of experience at some of the most
prestigious Wall Street firms and hedge funds, by providing a wide range of solutions like hedge
structuring and compliance advisory services.
7.2 Fund Offering and SEC requirements

The registration process of our fund will be governed by the Securities Act of 1933 and the
Investment Company Act of 1940. Specifically, FCM will utilize certain exemptions that both laws
offer in order to reduce its operating costs. Under Section 3 of the Company Act, the master
feeder fund can be exempt from registration under the 3(c)(1) private investment pool
exemption, which will allow FCM to avoid registration under the Company Act by restricting the
limited partners to no more than 100 accredited investors. The Securities Act will primarily
govern the offering registration process of the fund and according to Regulation D of the
Securities Act, FCM would be exempt from registering the offering of the fund, as the fund would
be offered as a Private Placement. To achieve this, Form U-2 and Form D must be filed with the
SEC and with each state in which FCM's limited partners reside. FCM will also apply for EDGAR
Codes so the fund can file its Form D with the SEC within 15 days of the initial fund closing, and
thus FCM will select a 506(b) classification filing under Regulation D. The fund's investors may
include up to 35 non-accredited participants. This whole process is crucial as it gives FCM the
25

opportunity to include a wide sampling of friends and family as initial investors. Finally, FCM
would ensure compliance with all full disclosure and anti-fraud provisions outlined by Section 12
of the Securities Act.
7.3 Fund name

Although the process of finding a name for the fund seems a pretty straightforward
procedure, there are a lot of small and important details that need to be considered. For example,
name restrictions and website and email addresses availability, are some of the most common
problems when naming a new firm. The legal counsel can run an intellectual property search to
ensure there are no restrictions on using our name. Finally, after a brief search of the United
States Patten and Trademark Office, Flow Capital Management seems to be without any
restrictions.
7.4 Formation of the fund

In general, a hedge fund can be constructed either as a single U.S. hedge fund, a single
offshore hedge fund or as a combination of both. The decision about the final structure of the
hedge fund will be mainly based on the tax considerations and implications for potential
investors. Flow Capital Management will adopt a master-feeder fund structure, with the
formation of a limited liability corporation as the management company. It is a combined hedge
fund structure where both domestic and offshore funds feed into a single offshore master fund.
This provides a very efficient way to raise capital across international borders, as U.S. investors
can contribute to the domestic fund, while foreign investors and tax-exempt U.S. investors can
participate in the offshore fund. Flow Capital Management will have a domicile in North America
and initial offices in San Francisco, California. The below graph represents a detailed description
of how a master-feeder constructed hedge fund operates.
26

General Assumptions
Year 1 2 3
Short Term Interest Rate 9.5% 9.5% 9.5%
Long Term Interest Rate 10.0% 10.0% 10.0%
Federal Tax Rate 33.0% 33.0% 33.0%
State Tax Rate 5.0% 5.0% 5.0%
Personnel Taxes 15.0% 15.0% 15.0%
Table 2. General Assumptions
Notes:
1. FCM Capital Management, LLC acts as
the GP to the domestic feeder and the
IM to the foreign feeder and the MF;
FCM Capital, LLC acts as the “general
partner” of the MF.
2. Investors place assets in the
domestic/offshore feeders
3. Feeders place assets in the MF
4. MF makes investments
5. Management Fee. At the end of Q1,
the BFs pays the IM a management
fee
6. Performance Fee. At the end of Y1:
the MF allocates BC (the “general
partner”) a Performance Allocation.
Other:
MF to be taxed as a partnership for US tax
purposes
Figure 9. Hedge Fund Master-Feeder Organization Chart
27

7.5 Prime Broker and Custodian Services
FCM will cooperate with more than one prime brokers in order to spread counterparty risks
across multiple brokers. FCM will examine carefully the services the fund needs in order to be
successful, and what each available prime broker is currently offering. The fund will clearly define
its strategy implementation plans, like trade volume, anticipated leverage, and position turnover,
in order to negotiate properly the terms of the relevant agreements. According to HedgeWeek,
prime brokers can provide security lending, trade clearing, margin finance and settlement, and
even some administrative and custodial services. FCM will search for a prime broker that can
deliver all these services within a packaged multifaceted prime brokerage agreement. Our firm
will target large, bank-owned prime brokers to ensure a long-term relationship that has all the
necessary capabilities. Although it may be more difficult to negotiate certain fees within the
prime brokerage agreement, planning for the growth of the fund is crucial. In addition, the task
of fund administration will also be provided by such a partner. Credit Suisse is a top-rated
administrator for both funds under $100 million and for larger $1 billion plus funds. FCM will
consider working with Credit Suisse as a prime broker and fund administrator. The fact that Credit
Suisse is a top-rated administrator makes it an ideal partner for FCM.
In addition, we will consider cooperating with Bank of America Merrill Lynch with regards to
fund administrator services like bank account services, fund accounting reporting services and
other important investor services. The infrastructure of our fund will be incorporated into the
systems of the selected prime broker. A full list of fund documentation, including tax information
and marketing materials will be sent to our firm’s prime brokers in order to initiate the process.
Finally, FCM will use outsourcing services for tasks like trade matching and settlement, margin
call and collateral management, trade and position valuation and affirmation and confirmation
of trades.
28

8 Ethics and Marketing Philosophy
8.1 Culture and Ethics

FCM will make sure that the right structures and processes are put in place in order to ensure
that staff welfare is well taken of. The company’s robust and flexible corporate culture is designed
to drive our business operations to greater heights, and regular training of our workforce is a top
priority of our business strategy. In addition, profit-sharing arrangements will be incorporated
for all of our management staff, which will be based on their performance for a period of two
years or more. This way, we will be able to successfully hire and retain the best minds we can get
in the industry. Our fund will adhere to a clearly defined set of values and ethical standards that
will promote integrity, professionalism and respect towards its clients and employees. We will
promote a meritocratic environment within a flat organizational structure driven 100 percent by
performance. FCM expects professionalism and ethical behavior from its employees at all times.
The good reputation as individuals and as a firm will be of paramount importance.
Although professional, the culture within the office should be informal, thus encouraging
better communication and collaboration between its employees. As a relationship-driven firm,
FCM’s employees will be deeply committed to building and maintaining long-term external and
internal relationships grounded in transparency and trust. Achievement of investment goals and
satisfaction of investors’ needs will be the two main factors that define the overall success of the
fund. Last but not least, the employees should take reasonable measures in order to protect the
firm’s reputation inside and outside the job.
8.2 General Marketing Philosophy

One of the major goals of Flow Capital Management, is to build a long-term business that
will survive off its own cash flow without the need for “injecting” finance from external sources.
By generating good and consistent returns on the investments, our fund will gain the trust and
approval of its clients. In such a highly competitive environment, new ideas can flourish only with
carefully constructed marketing strategies that appeal to investors’ needs and preferences. At its
very core, the main marketing philosophy of the fund should strive to satisfy the clients’ needs
29

and wants, while at the same time achieving the firm’s goals. The three major marketing
philosophy strategies that will help our firm increase its chances of raising capital are based on
the below concepts.
Firstly, the concept of simplicity where the products and strategies of the fund will be
explained in a simple and understandable manner to the investors. Helping investors understand
the main dynamics of the firm in a simple and concise way can make all the difference, especially
during the initial stages of fund raising. Secondly, ongoing communication with clients, including
updates, one to one meetings, and strategy discussions will also be crucial in order to build trust
and long-term relationships. Building a brand that offers high quality investment products with
innovative features will be the last step of the marketing process. Last but not least, FCM will
introduce an innovative internal marketing scheme for promoting the firm’s objectives, services
and products within the organization. By keeping employees happy and engaged, the external
branding and marketing efforts will strengthen further.
8.3 Detailed Marketing Plan

Flow Capital Management will use some of the following marketing strategies to attract clients:
• We will advertise our business properly in various financial and business-related

newspapers, magazines and TV stations.
• We will introduce our business by sending introductory letters alongside our official
brochure to various corporate organizations, accredited investors and key stake holders
in San Francisco and other cities in the United States.
• We will encourage word of mouth marketing from loyal and satisfied clients and provide
extra initiatives like reduced management fees to them.
• We will leverage of the internet and social media platforms like Facebook, Twitter and
Google + to promote our brand.
• We will attend international and local finance and business expos, business fairs and other
related seminars.
• We will install our Bill Board on various strategic locations around San Francisco.
30

• We will create different packages for different categories of clients in order to work with
their budgets and still deliver good returns on investment.
• We will make extensive use of various direct marketing approaches.
Breakdown of Marketing Costs
Total Short Term Marketing

Total Intermediate Marketing
Total Long Term Marketing
Figure 10. Breakdown of Marketing Costs
Marketing ROI
Year 1 2 3
Short Term Marketing
Billboards $1,680 $1,710 $1,945
Radio Advertisements $672 $684 $778
TV Advertisements $6,720 $6,840 $7,780
PPC Marketing $4,368 $4,446 $5,057
Total Short Term Marketing $13,440 $13,680 $15,560
Intermediate Term Marketing

Brochuers $5,040 $5,130 $5,835
Mailers $6,720 $6,840 $7,780
Total Intermediate Marketing $11,760 $11,970 $13,615
Long Term Marketing

Website Search Engine Optimization $3,360 $3,420 $3,890
General Company Branding $5,040 $5,130 $5,835
Total Long Term Marketing $8,400 $8,550 $9,725
Total Marketing Costs $33,600 $34,200 $38,900

Total Net Profits $1,859,672 $2,064,109 $2,462,772
Total Marketing ROI 5534.74% 6035.41% 6331.03%
Marketing Breakdown
Year 1 2 3
Short Term Marketing
Billboards 5.00% 5.00% 5.00%
Radio Advertisements 2.00% 2.00% 2.00%
TV Advertisements 20.00% 20.00% 20.00%
PPC Marketing 13.00% 13.00% 13.00%
Intermediate Term Marketing

Brochuers 15.00% 15.00% 15.00%
Mailers 20.00% 20.00% 20.00%
Long Term Marketing

Website Search Engine Optimization 10.00% 10.00% 10.00%
General Company Branding 15.00% 15.00% 15.00%
Total Marketing Costs (%) 100.00% 100.00% 100.00%
Table 3. Marketing ROI

31

9. Capital Raising
9.1 General Capital Raising Plan
In order to make a successful fund launch, Flow Capital Management needs to attract the
right amount of capital for funding its operations, as well as to demonstrate a scalable process.
The main target of our fund is to raise between $100 and $150 millions of investment capital for
its first fund. A clearly articulated pitch, explaining the main philosophy and innovative
investment and technological approaches of the firm, will help in distinguishing it from the rest
of the competition. Table 7 shows the estimated yearly sales forecast of FCM for the next 5 years.
As the fund grows, FCM would anticipate offering separately managed accounts in addition to
the initial co-mingles structure, where each investor is a separate limited partner of the
partnership.
9.2 Exact Cost Model and Projected Revenue

The fees that Flow Capital Management will charge its clients will be 1.35% for management
fees and 17.33% for performance fees, pursuing to satisfy the need of investors for lower charges.
With a mean management and performance industry fee of 1.56% and 19.33% respectively, FCM
will try to adjust to investors’ needs, by providing lower fees while at the same time increasing
the value of its services. To make the firm more competitive in the long-run, we will also
introduce a series of competitive policies that will attract the attention of investors. For example,
the mean lock-up period will be reduced to 12 months, thus providing more security and control
to investors over their assets. In addition, the median redemption notice period will be reduced
to only 30 days, and the median redemption frequency to 60 days, which is 15 days and 30 days
less respectively than the average values of San Francisco based Hedge funds.
The motto of Flow Capital Management will be “High Performance, great flexibility, low
fees”. Furthermore, our fund will provide strong referral schemes to its clients, and guarantee
of reduced management and performance fees of at least 7% and 9% respectively compared to
the competition. This way, we will ensure a head start for the fund, as well as the establishment
of long-term and meaningful relationships with our investors. Perqin data showed that event
driven strategies generated an average return of 12.47% in the previous year, and smaller funds
32

were able to generate the greatest returns in 2016. Therefore, it is reasonable to assume
compounded annual returns of 15% to 25% per year for FCM, especially after considering its
innovative algorithmic trading strategies and risk management approaches.
Mean Management Mean Performance Media Redemption Median Redemption Mean Lock-up Period
Column1
Fee % Fee % Frequency (Days) Notice Period (Days) (Months)
Flow Capital Management 1.35 17.33 60 30 12
San Francisco-Based Hedge Funds 1.56 19.33 90 45 13
Figure 11. Mean Terms and conditions of Flow Capital Management vs. San Francisco-Based
Hedge Funds*
Projected Startup Costs

Business Startup Year 1
Initial Lease Payments and Deposits $60,000
Working Capital $1,000,000
FF&E $125,000
Leasehold Improvements $110,000
Security Deposits $105,000
Insurance $60,000
Investment Capital $8,500,000
Marketing Budget $75,000
Miscellaneous and Unforeseen Costs $25,000
Total Startup Costs $10,060,001
Financing
Equity Contributions
Investors $150,000,000.00
Total Equity Financing $150,000,000.00

Banks and Lenders
Total Debt Financing $0.00

Total Financing $150,000,000.00
Table 4. Projected Startup Costs
*
Special Circumstances apply to extreme market conditions
33

0% Use of Funds
1% Initial Lease Payments and
1% 1% Deposits
1% Working Capital
1%
10% FF&E
1%
Leasehold Improvements
84% Security Deposits
Insurance
Figure 12. Use of Funds
Inventory
Product Name Cost Per Unit Profit Per Item Revenue Per Item
Long/Short Strategy $3.47 $104.00 $107.47
Black Box Strategy $3.00 $95.00 $98.00
Cryptocurrencies $3.80 $70.00 $73.80
Event Driven $4.30 $84.00 $88.30
Relative Value Strategy $3.50 $88.00 $91.50
Personnel Summary
Position Growth (%) 1 2 3
Senior Management 3.5% $150,000 $155,250 $160,684
Investment Analysts 3.4% $90,000 $93,060 $96,224
Accountants 2.8% $87,000 $89,436 $91,940
Traders 3.0% $120,000 $123,600 $127,308
Administrative 1.9% $45,000 $45,855 $46,726
Total 2.9% $492,000 $507,201 $522,882
Anticipated Yearly Expenses

Year 1 2 3
General and Administrative $44,500 $45,600 $47,300
Marketing Expenses $33,600 $34,200 $38,900
Professional Fees and Licensure $57,300 $58,500 $59,678
Insurance Costs $62,200 $63,700 $65,354
Travel and Vehicle Costs $69,000 $74,567 $79,567
Rent and Utilities $64,300 $66,345 $69,100
Miscellaneous Costs $39,500 $42,300 $44,987
Totals $370,400 $385,212 $404,886
Table 5. Startup Inventory and Anticipated Yearly Expenses
34

9.3 Exit strategy
The Management of FCM believes that after the fifth year the company will be ready for an
IPO or we can sell it to another big international competitor. Specifically, FCM has planned two
possible different exit strategies. The first strategy would be to sell the fund for five to ten times
earnings to a larger entity at a significant premium. The second exit scenario would be to sell a
portion of FCM via an initial public offering. After performing a thorough analysis in the sector,
we found that the fund can be sold for ten to twenty times earnings on the open market,
depending on the strength of earnings and the business’s annual growth rate.
9.4 Breakeven Analysis
Breakeven analysis includes the calculation and examination of the margin of safety for our firm
and is based on the collected revenues and associated costs. By analysing different
price levels relating to various levels of demand, FCM can use the below break-even
analysis in order to determine what level of sales are needed to cover total fixed costs.
Monthly Break Even Analysis

Year 1 2 3
Monthly Revenue $80,755 $120,433 $134,451
Yearly Revenue $969,059 $1,445,194 $1,613,415
Table 6. Monthly Break-Even Analysis
Break Even Analysis
$2.000.000
$1.000.000
Monthly Revenue
Yearly Revenue
$0
1 2 3
Year
Figure 13. Breakeven Analysis
35

Yearly Sales Forecast
Year 1 2 3 4 5
Growth (%) 0.0% 20.0% 17.0% 14.0% 12.0%
Long/Short Strategy $1,167,769 $1,401,323 $1,639,548 $1,869,084 $2,093,375
Black Box Strategy $2,129,736 $2,555,683 $2,990,149 $3,408,770 $3,817,823
Cryptocurrencies $176,420 $211,704 $247,694 $282,371 $316,256
Event Driven $301,191 $361,430 $422,873 $482,075 $539,924
Relative Value Strategy $312,107 $374,528 $438,198 $499,545 $559,491
Totals $4,087,223 $4,904,668 $5,738,461 $6,541,846 $7,326,867
Cost of Sales Forecast

Year 1 2 3 4 5
Growth (%) 0.0% 20.0% 17.0% 14.0% 12.0%
Long/Short Strategy $37,705 $45,246 $52,938 $60,349 $67,591
Black Box Strategy $65,196 $78,235 $91,535 $104,350 $116,872
Cryptocurrencies $9,084 $10,901 $12,754 $14,539 $16,284
Event Driven $14,667 $17,601 $20,593 $23,476 $26,293
Relative Value Strategy $11,939 $14,326 $16,762 $19,108 $21,401
Totals $138,591 $166,309 $194,581 $221,823 $248,442
Gross Profit
Year 1 2 3 4 5
Total $3,948,632 $4,738,359 $5,543,880 $6,320,023 $7,078,426
Table 7. Yearly Sales Forecast
Yearly Sales
$4.000.000
$3.000.000 1 2
$2.000.000
3 4
$1.000.000
5
$0
Long/Short Strategy Black Box Strategy
Figure 14. Yearly Sales Forecast
36

Personnel Analysis - Monthly
Month 1 2 3 4 5 6 7 8 9 10 11 12
Senior Management $12,500 $12,500 $12,500 $12,500 $12,500 $12,500 $12,500 $12,500 $12,500 $12,500 $12,500 $12,500
Investment Analysts $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500 $7,500
Accountants $7,250 $7,250 $7,250 $7,250 $7,250 $7,250 $7,250 $7,250 $7,250 $7,250 $7,250 $7,250
Traders $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000
Administrative $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750
Totals $41,000 $41,000 $41,000 $41,000 $41,000 $41,000 $41,000 $41,000 $41,000 $41,000 $41,000 $41,000
Table 8. Personnel Analysis - Monthly
Numbers of Personnel
Year 1 2 3 4 5
Senior Management 1 2 2 2 2
Investment Analysts 1 2 3 3 3
Accountants 1 1 1 2 2
Traders 1 2 2 2 2
Administrative 1 1 1 1 2
Totals 5 8 9 10 11
Table 9. Numbers of Personnel
Personnel Expense Breakdown
Senior Management
9% 31%
24% Investment Analysts
18% 18% Accountants

Traders
Administrative
Figure 15. Personnel Expense Breakdown
37

Personnel Plan - Yearly
Year 1 2 3
Senior Management $150,000 $310,500 $321,368
Investment Analysts $90,000 $186,120 $288,672
Accountants $87,000 $89,436 $91,940
Traders $120,000 $247,200 $254,616
Administrative $45,000 $45,855 $46,726
Total $492,000 $879,111 $1,003,322
Numbers of Personnel
Year 1 2 3
Senior Management 1 2 2
Investment Analysts 1 2 3
Accountants 1 1 1
Traders 1 2 2
Administrative 1 1 1
Totals 5 8 9
Table 10. Personnel Plan and Numbers of Personnel
Personnel Expense Breakdown
Senior Management
9% 31%
24% Investment Analysts
18% 18% Accountants

Traders
Administrative
Figure 16. Personnel Expense Breakdown
38

Proforma Profit and Loss (Yearly)
Year 1 2 3
Sales $4,087,223 $4,904,668 $5,738,461
Cost of Goods Sold $138,591 $166,309 $194,581
Gross Margin 96.61% 96.61% 96.61%
Operating Income $3,948,632 $4,738,359 $5,543,880
Expenses
Payroll $492,000 $879,111 $1,003,322
General and Administrative $44,500 $45,600 $47,300
Marketing Expenses $33,600 $34,200 $38,900
Professional Fees and Licensure $57,300 $58,500 $59,678
Insurance Costs $62,200 $63,700 $65,354
Travel and Vehicle Costs $69,000 $74,567 $79,567
Rent and Utilities $64,300 $66,345 $69,100
Miscellaneous Costs $39,500 $42,300 $44,987
Payroll Taxes $73,800 $131,867 $150,498
Total Operating Costs $936,200 $1,396,190 $1,558,706
EBITDA $3,012,432 $3,342,169 $3,985,174

Federal Income Tax $994,103 $1,102,916 $1,315,107
State Income Tax $150,622 $167,108 $199,259
Interest Expense $0 $0 $0
Depreciation Expenses $8,036 $8,036 $8,036
Net Profit $1,859,672 $2,064,109 $2,462,772

Profit Margin 45.50% 42.08% 42.92%
Proforma Profit and Loss (Yearly)

Year 1 2 3
Sales $4,087,223 $4,904,668 $5,738,461
Operating Costs $936,200 $1,396,190 $1,558,706
EBITDA $3,012,432 $3,342,169 $3,985,174
Taxes, Interest, and Depreciation $1,152,760 $1,278,060 $1,522,402
Net Profit $1,859,672 $2,064,109 $2,462,772
Table 11. Proforma Profit and Loss (Yearly)
39

Profit and Loss Statement (Third
Year)
3
Quarter Q1 Q2 Q3 Q4 3
Sales $1,147,692 $1,434,615 $1,549,385 $1,606,769 $5,738,461
Cost of Goods Sold $38,916 $48,645 $52,537 $54,483 $194,581
Gross Margin 96.6% 96.6% 96.6% 96.6% 96.6%
Operating Income $1,108,776 $1,385,970 $1,496,848 $1,552,286 $5,543,880
Expenses
Payroll $200,664 $250,831 $270,897 $280,930 $1,003,322
General and Administrative $9,460 $11,825 $12,771 $13,244 $47,300
Marketing Expenses $7,780 $9,725 $10,503 $10,892 $38,900
Professional Fees and Licensure $11,936 $14,920 $16,113 $16,710 $59,678
Insurance Costs $13,071 $16,339 $17,646 $18,299 $65,354
Travel and Vehicle Costs $15,913 $19,892 $21,483 $22,279 $79,567
Rent and Utilities $13,820 $17,275 $18,657 $19,348 $69,100
Miscellaneous Costs $8,997 $11,247 $12,146 $12,596 $44,987
Payroll Taxes $30,100 $37,625 $40,635 $42,140 $150,498
Total Operating Costs $311,741 $389,677 $420,851 $436,438 $1,558,706
EBITDA $797,035 $996,293 $1,075,997 $1,115,849 $3,985,174

Federal Income Tax $263,021 $328,777 $355,079 $368,230 $1,315,107
State Income Tax $39,852 $49,815 $53,800 $55,792 $199,259
Interest Expense $0 $0 $0 $0 $0
Depreciation Expense $2,009 $2,009 $2,009 $2,009 $8,036
Net Profit $492,153 $615,693 $665,109 $689,817 $2,462,772

Table 12. Profit and Loss Statement (Third Year)
40

Proforma Cash Flow Analysis - Yearly
Year 1 2 3
Cash From Operations $1,867,708 $2,072,145 $2,470,808
Cash From Receivables $0 $0 $0
Operating Cash Inflow $1,867,708 $2,072,145 $2,470,808
Other Cash Inflows

Equity Investment $150,000,000 $0 $0
Increased Borrowings $0 $0 $0
Sales of Business Assets $0 $0 $0
A/P Increases $37,902 $43,587 $50,125
Total Other Cash Inflows $150,037,902 $43,587 $50,125
Total Cash Inflow $151,905,610 $2,115,732 $2,520,933
Cash Outflows
Repayment of Principal $0 $0 $0
A/P Decreases $24,897 $29,876 $35,852
A/R Increases $0 $0 $0
Asset Purchases $8,875,000 $996,087 $1,146,095
Dividends $0 $581,051 $668,555
Total Cash Outflows $8,899,897 $1,607,015 $1,850,502
Net Cash Flow $143,005,713 $508,718 $670,431

Cash Balance $143,005,713 $143,514,431 $144,184,862
Table 13. Proforma Cash Flow Analysis – Yearly
Proforma Cash Flow (Yearly)
$200.000.000
$150.000.000
$100.000.000 Total Cash Inflow

Total Cash Outflows
$50.000.000
Cash Balance
$0
1 2 3
Year
Figure 17. Proforma Cash Flow (Yearly)
41

Cash Flow Analysis (Third Year)
3
Quarter Q1 Q2 Q3 Q4 3
Cash From Operations $494,162 $617,702 $667,118 $691,826 $2,470,808
Cash From Receivables $0 $0 $0 $0 $0
Operating Cash Inflow $494,162 $617,702 $667,118 $691,826 $2,470,808
Other Cash Inflows

Equity Investment $0 $0 $0 $0 $0
Increased Borrowings $0 $0 $0 $0 $0
Sales of Business Assets $0 $0 $0 $0 $0
A/P Increases $10,025 $12,531 $13,534 $14,035 $50,125
Total Other Cash Inflows $10,025 $12,531 $13,534 $14,035 $50,125
Total Cash Inflow $504,187 $630,233 $680,652 $705,861 $2,520,933
Cash Outflows
Repayment of Principal $0 $0 $0 $0 $0
A/P Decreases $7,170 $8,963 $9,680 $10,038 $35,852
A/R Increases $0 $0 $0 $0 $0
Asset Purchases $229,219 $286,524 $309,446 $320,907 $1,146,095
Dividends $133,711 $167,139 $180,510 $187,195 $668,555
Total Cash Outflows $370,100 $462,625 $499,635 $518,141 $1,850,502
Net Cash Flow $134,086 $167,608 $181,016 $187,721 $670,431

Cash Balance $143,648,517 $143,816,125 $143,997,141 $144,184,862 $144,184,862
Table 14. Cash Flow Analysis (Third Year)

Business Ratios - Yearly
Year 1 2 3
Sales
Sales Growth 0.0% 20.0% 17.0%
Gross Margin 96.6% 96.6% 96.6%
Financials
Profit Margin 45.50% 42.08% 42.92%
Assets to Liabilities 11004.24 5412.77 3572.01
Equity to Liabilities 11003.24 5411.77 3571.01
Assets to Equity 1.00 1.00 1.00
Liquidity
Acid Test 10996.21 5371.87 3517.59
Cash to Assets 1.00 0.99 0.98
Table 15. Business Ratios - Yearly
42

Proforma Balance Sheet - Yearly
Year 1 2 3
Assets
Cash $143,005,713 $143,514,431 $144,184,862
Amortized Development/Expansion Costs $52,500 $152,109 $266,718
Inventory $35,000 $533,044 $1,106,091
FF&E $25,000 $423,435 $881,873
Accumulated Depreciation ($8,036) ($16,071) ($24,107)

Total Assets $143,110,177 $144,606,947 $146,415,437
Liabilities and Equity

Accounts Payable $13,005 $26,716 $40,990
Long Term Liabilities $0 $0 $0
Other Liabilities $0 $0 $0
Total Liabilities $13,005 $26,716 $40,990
Net Worth $143,097,172 $144,580,231 $146,374,447

Total Liabilities and Equity $143,110,177 $144,606,947 $146,415,437
Table 16. Proforma Balance Sheet – Yearly
Proforma Balance Sheet
$160.000.000
$140.000.000
$120.000.000
$100.000.000
$80.000.000 Total Assets
$60.000.000 Total Liabilities
$40.000.000 Net Worth
$20.000.000
$0
1 2 3
Year
Figure 18. Proforma Balance Sheet
43

Figure 19. Organizational Overview
44

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48

Setting Up of A New Quantitative Finance Firm: Business Plan, Market Driver, Capital Raising and Ethics

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Setting up of a New Quantitative Finance Firm:

Business Plan, Market Driver, Capital Raising and Ethics

Electronic copy available at: https://ssrn.com/abstract=3202251

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Upon request, this document is to be immediately returned.

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1 The Hedge Fund Industry

2 Structure Plan of the fund

3 Investment Allocation Strategies

4 Long-Term Survival of the fund and Expansion Plan

5 Trading Models and Strategies of the fund

6 Risk Management Strategies

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8 Ethics and Marketing Philosophy

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1.3 Regulation and Compliance

2. Structure plan of the fund

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2.2 Fund Launch Plan

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Figure 1. Top Cities by Hedge Fund Assets under management

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Figure 3. Strategy Preferences of San Francisco-Based Investors

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2.4 Target Market

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3. Investment Allocation Strategies

3.1 Main Strategy of the fund

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3.2.2 Event-Driven Strategy

3.2.3 Relative Value Arbitrage Strategy

3.2.4 Investments in Cryptocurrencies

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3.2.4.1 Current Regulation in Cryptocurrencies

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Monthly Sales Analysis - Units

Monthly Sales Analysis - Cost of Sales

Monthly Sales Analysis - Gross Profit

Table 1. Monthly Sales

Monthly Sales (Units)

1600 Long/Short Strategy Black Box Strategy

Figure 6. Monthly Sales (Units)

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$160,000 Long/Short Strategy

Figure 7. Sales Revenue by Product

4 Long Term Survival of the Fund and Expansion Plan

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4.2 Expansion plan to BRICS

5 Trading models and strategies of the fund

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5.2 Hybrid Machine Learning Trading models

Figure 8. Structure of a proposed hybrid trading system

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6 Risk Management Strategies

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6.2 Models to handle market shocks

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6.3 Models to handle redemption pressure

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