The Concept

Create an investment vehicle that will:

• Collect money from investors.
• Invest that money into anything money markets, bonds, stocks, commodities, real estate whatever makes sense.
• Use derivatives to hedge or make outsized bets or what have you.
• Have limited liability for the members restricted to their investment capital.
• Allow for partial or full exits. additions of new investors and addition of extra capital at any time.
• Compensate the fund managers in a transparent and simple manner. Typically there is an annual management fee, and a profit sharing fee, with a hurdle rate and a high watermark.

This is the typical structure of a hedge fund or venture fund. Once you have such a structure, you can then create the investment plan and approach investors for capital.

This applies if you want to create a fund to invest in startups as well, a PE or VC fund.

Lets say I figured that certain stocks are cheap today, and banks expensive. In the next two years, bonds will peak. We will also see real estate prices bottoming out after that, and in the meantime, there will be long and short opportunities in all sorts of markets. Can I create a fund that allows a few friends to put in their money behind my assertions?

Notes and Points to Consider

Taxation. Some investors might prefer an independently taxed entity (like an company). It saves them hassles of putting the gains into their accounts, and then having to file returns for business income. Foreign investors, on the other hand, prefer pass-through mechanisms, where the capital gains occurs in their hands, since Mauritius based FIIs pay no cap-gains taxes. Other VHNIs may want to offset other losses with your investment gains, and prefer pass-through.

For the tax department, there is capital gains for most investments. Income from derivatives is business income, unless you can prove it is a hedge or such. Income from intraday trading is speculative income.

Pooling. It is useful to collect the capital in one entity or account and invest, compared to having to manage separate individual investor accounts. For example, if I need to buy 10 lots of Reliance Industries, and I have six equal investors, what do I do if they all have separate accounts? If it were pooled I could buy the 10 lots out of the single account, and eventually distribute the profits. Unfortunately some of the structures dont allow pooling.

Regulators. Remember that if you put this out there for *anyone* to invest, SEBI will get ticked off; this investment vehicle must be restricted only to people you know. (Unless you choose the SEBI registered options) Other regulatory issues are about if you need a minimum capital to apply.

Foreign investors. Three different categories exist institutions (FIIs), foreign individuals and Non Resident Indians (NRIs or PIOs). Some can buy in India, some cant. FIIs cant buy into certain sectors. NRIs cant buy Indian company debt. Such ring fencing impacts the structure you create. Foreign individuals cant invest in most structures, so lets consider FIIs or NRIs in this discussion.

To understand, lets see what kind of structures exist.

A Partnership

My friends and I could enter into a partnership, but this does not let me do limited liability. Plus, the partnership will have trouble opening brokerage accounts and so on. This route is closed before further discussion.

An Advisory

I create a company called Shenoy Advisors, in which I am the primary investor. I then ask my investors to create accounts with a brokerage, a bond dealer, a mutual fund, and so on. When I finalize an investment or a change, I talk to each investor and tell him to do this transaction. At the end of each quarter, I give them an account of the profits and hope that they will pay me.

Why hope? Because a contract may not necessarily give me the legal right to charge profit-sharing fees, which SEBI might maintain is only chargeable by SEBI registered PMS providers (discussed later). Im not very clear about this but there are opinions favouring SEBIs argument.

Taxation. Pass through.

Pooling. Not allowed.