What is a hedge fund? - 101
I started writing my own personal story about starting a hedge fund and realized I better lay the foundation of what a hedge fund actually is before I jump into my personal experience as many are confused.
I started writing my own personal story about starting a hedge fund and realized I better lay the foundation of what a hedge fund actually is before I jump into my personal experience as many are confused.
When I started at Salomon in 1986 hedge funds like Steinhardt and Soros existed and were important factors in markets but the industry wasn't anything like what it would be come over the ensuing decades. I guess I should start with what defines a hedge fund.
A hedge fund is simply an investment pool where the hedge fund manager can position the fund in a way limited only by his investor's mandate. That means he can go long or short any asset and use leverage. This differs from traditional money management as most traditional
Investment pools are long only and either unleveraged or use modest leverage. Those are things like mutual funds, insurance variable annuities, money market funds, pension funds etc. The fact that hedge funds can go short is why they were originally called "hedge" funds.
Today hedge funds employ a wide range of different strategies. They are labeled as such. But even within those labels the strategies can be vastly different. But let's step back to Alpha and Beta. In my opinion given the fees charged by Hedge Funds it is essential that they
Deliver alpha. Alpha is absolute performance. It's outperformance of benchmark, it's not correlated with owning a portfolio of assets.
It is incredibly inexpensive to own the market and receive the return the market provides. That is BETA. Alpha is very hard to get
It is incredibly inexpensive to own the market and receive the return the market provides. That is BETA. Alpha is very hard to get
Active managers both at hedge funds and in the rest of the investment space are constantly picking stocks, swapping from one part of the yield curve to another, asset allocating, hedging, going to and from cash, moving exposures around internationally. All of them are looking
For alpha. They want to outperform the market portfolio. BUT that money has to come from another active manager. Alpha is zero sum. Hedge funds in particular are alpha seekers. In my view the only way to measure a hedge fund is on alpha. Which means any
Correlation to market returns (which is beta) deserves no extra compensation. Let's briefly touch on why Hedge funds draw the smartest portfolio managers. It's the fees. Despite years of fee contraction pressure the best hedge funds are still able to command 2% fee per year on
AUM and also take 20% of the positive return provided gross to the investor. When you add the fair value of the 20% performance fee onto the AUM fee you are talking about 4% per year fees vs 0.07% for a vanguard index fund. Ask Willie Sutton why to rob banks.
So do the best PM's. So these funds attempt to deliver alpha. They may take pure beta risk as well. Sometimes systematically who wouldn't? The markets usually go up and you get 20% of the ups. But investors have become smarter and won't pay for market exposures they can
Create cheaply. Lol. That's not true. The great funds dictate the terms.
I am passionate about the topic obviously. It genuinely pisses me off when investors pay 2 and 20 for Beta. While it may sound like I am being a "homer" given my background. All the funds down this year
I am passionate about the topic obviously. It genuinely pisses me off when investors pay 2 and 20 for Beta. While it may sound like I am being a "homer" given my background. All the funds down this year
With the market because they buy cheap stocks are a joke. Bridgewater and Brevan each have delivered ridiculously high double digit returns in a year when Beta has failed. That's what you pay 2/20 for. Not these beta in alpha clothing funds. Find absolute return hedge fund that
Deliver uncorrelated returns. Now that's worth paying for.
Off my soap box. Hedge funds generally break down into
Corporate asset pickers, mostly stock pickers but credit too
Event Driven - merger arb, bankruptcy, special situations
RV A broad bucket of funds do relative
Off my soap box. Hedge funds generally break down into
Corporate asset pickers, mostly stock pickers but credit too
Event Driven - merger arb, bankruptcy, special situations
RV A broad bucket of funds do relative
Value investing in a narrow silo of the global markets or many pods of silos within one fund. Converts, credit, FI, vol strategies are some examples
Macro - what I do is everything from diverse systematic alpha across 100 markets to one big discretionary bet.
Macro - what I do is everything from diverse systematic alpha across 100 markets to one big discretionary bet.
Multi strategy funds do some or all of these strategies within one fund.
All leverage. The idea with absolute return is your benchmark is short term cost of money or zero. Then particularly in relative value investments you attempt to extract say 100bp a year on the relationship
All leverage. The idea with absolute return is your benchmark is short term cost of money or zero. Then particularly in relative value investments you attempt to extract say 100bp a year on the relationship
But 100bp sucks. So you leverage 10:1 and generate double digit returns. Of course the decades are littered with funds using this strategy who missed the macro and blew up on this leverage. But inherently the idea is sound. But the big problem comes back to beta. When these
Levered funds blow up. It's usually when markets are down. That's the opposite of uncorrelated alpha. That's the worst case of Beta. And yet again and again investors pay 2/20 for this trash. Oops started ranting again. I'll end with this
Alpha exists. It is hard to find but when uncorrelated to markets is an extremely important way for investors to diversify their portfolio. Alpha also requires the ability to use a wide range of investment products both long and short. It also requires leverage as the alpha
Is usually small and moves fast. Leverage isn't always a dirty word and many firms use it with great skill. Given all that one of the few ways to collect alpha is by investing with a hedge fund and paying those fees. But make sure you are paying for alpha. Make sure they have
A process that you can believe delivers alpha and make sure you understand their leverage. Lastly if they sound like they are investing in beta run away.
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