Hedge Funds Unplugged.Hedge funds are investment firms that invest money any way they see fit; they trade almost anything and can go short as quickly as they go long. If a fund manager thinks the New York Giants are going to whip the Dallas Cowboys, he can bet on it. Unlike other financial institutions, hedge funds are not subject to SEC regulations. While several of these firms have wreaked a little havoc in the past, the industry claims regulation would limit the returns. The law states advertising is not allowed. This probably adds to the mystique. Hedge funds usually hire an outside marketing firm to attract investors and capital. If you’d like to invest in a fund you need a million dollar net worth or an income of $200,000 for at least two years. Most funds service institutions while funds with assets of less than $100 million dollars will cater to high-net individuals.
While hedge funds have their own investment style they all share this goal: Create a diversified portfolio of financial products that outperform the market come bull or bear.
Hedge funds do get some criticism. These include: • Size- As these funds grow to humongous proportions their ability to generate stellar returns decline. • Leverage- Many funds are highly leveraged. If the financial markets go against them, the results can be disastrous. Not only for the fund but for the whole market. LTCM and George Soros. Enough said. • Monitoring- Hedge funds don’t have regulators looking over their shoulder. It’s hard to know exactly what’s being traded. • Head for the Hills- If fund investors get spooked, they can withdraw their money. There have been mass exoduses. Hedge funds put up huge cash positions to form complex structures, this can prove detrimental to the fund and the market. Funds assume greater risk than other money managers so their returns do not fit a normal profile. There will be occasions of huge returns and occasions of huge losses. A measurement known as Value at Risk (VaR), is used to predict within a certain confidence level, what the maximum amount of money a fund can lose within a certain environment. With that being said, hedge funds have the reputation of “usually” beating mutual funds. They can exploit down markets as well as up ones. Funds invest in certain types of markets and strategies. Here’s a sample: • Beat-up companies- Purchase the debt or equity of companies facing bankruptcy or reorganization. Other institutional investors cannot own below grade securities so this pushes the prices even lower. This creates opportunities if the stock should rise again or the company is purchased. • Special Situations- Strategies include mergers, hostile takeovers, leveraged buyouts etc… An example is the simultaneous purchase of an acquired company’s stock and the sale of the acquiring firm’s stock. The goal is to profit from the spread between the market price and ultimate purchase price of the company. • Market Neutral: Stocks- Purchase equal long and short equity positions within the same sector, market or between different stocks . Leverage is sometimes used to enhance returns. Money is made regardless of what direction the investment takes. • Arbitrage- A manager instantaneously purchases an asset in one exchange and sells it in another realizing a profit from a momentary price discrepancy. • Global Macro-Investing- Capitalize on changes in political climate, unrest or global economies. These policy shifts can create opportunity in stocks, bonds, commodities or interest rates. • Fund of Funds- Invest in several hedge funds each with differing strategies • Aggressive Growth- This strategy purchases smaller cap stocks expected to experience high growth. These stocks are hedged with securities that are expected to take a tumble. Again, money can be made both ways • Derivatives Powerful financial products whose value is based on an underlying asst. These assets can be bonds, stocks, oil, commodities, currency and mortgages. In some cases, a relatively small amount of money can go a long, long way. Derivatives include swaps, futures, options or a combination. Is it possible? Would your friendly neighborhood hedge fund give you insider information? As long as the SEC is around they will. Whenever a hedge fund acquires more than 5% of a company they must disclose it under SEC Rule 13D or 13G within 10 days. You can track their daily report filings at www.SEC.gov. Pull up the 13D’s & 13G’s and put together your new “buy” list. Some hedge funds are more successful than others. If you see purchases from SAC Capital, Citadel Investment or ESL Investments, highlight them.
Fund managers have a lot of leeway in how they invest money. They use extremely complex strategies in which outcomes are dependant on several variables. How do they manage it all? Computers and rocket scientists. Advanced software and quantitative analysts develop models than predict what would happen to an asset or market if certain variables exist. These models work wonders in fairly stable markets.
Problems occur when anomalies are thrown into the mix. Models don’t take into account: war, scandals, bankruptcies, suprise tax hikes and unpredictable interest rate changes. Investment requirements for hedge funds range from $50,000 to $100 million dollars. If you get a chance to invest in a hedge fund, don’t forget to drop me an email. Cause the chances are, you won’t be reading this site. Go From Hedge Funds To The Banks
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