So all the author is saying is that giving a "black box" a lot of money, and letting it opaquely invest however it wants, will be a winning investment strategy in the future, even though right now it isn't working out so well.
[0] Of course they have documents that explain the strategy, agree to certain things, etc. I'm simplifying it a bit.
That's the best description of a hedge fund that I've heard. Likewise, I don't see how that will ever be a winning investment strategy. You'd be better off with just an index ETF.
Put another way, Startups are just narrowly defined hedge funds. You can be adverse in investing in a risky startup and still be bullish about startups in general.
That's not the most accurate. Many (most?) hedge funds don't lock funds for any significant amount of time; the most would be a few months, and even that not because they hold illiquid investments, but because they want to discourage investors that react too emotionally on market moves. I'm guessing your description is more appropriate for VCs and Private Equity.
Hedge Funds do, however, execute strategies not available to "traditional" instituational investors, but that is mostly because of regulatory constraints - e.g. index tracking funds can advertise to the public, hold pension investments etc., whereas hedge funds can't. Another difference is that hedge funds usually have a much broader investment mandate - e.g. a bond mutual fund has to invest the majority of its AUM into bonds, even if everyone believes bond prices will drop, whereas a hedge fund could simply sell everything and keep cash or buy stock or whatever its managers believe will make money. The flip side of this is that "traditional" investment institutions are measured against benchmarks (e.g. if a bond fund makes -20% in a year when a bond index made -21%, the bond fund "outperformed"), but hedge funds are measured absolutely (profit is good, loss is bad) and get paid peanuts if they don't make a profit.
I wouldn't call a guaranteed 2% shave every year 'peanuts'. That's more than any index fund would ever imagine charging.
There's no hard definition of it.
VC firms are essentially a kind of 'hedge fund' though we don't think of them that way.
Most hedge funds do have long 'lock up periods'.
Whether they are a 'good investment' is like asking is a specific home a 'good investment'. It depends on the home. They vary wildy in terms of quality etc...
This hasn't been my experience. In my experience at a couple firms, redemption schedules have always been tightly controlled to ensure predictable AUM and minimize forced rebalancing of strategies.
Additionally, there are a lot of nuances of hedge funds that are being missed in the comments. Hedge funds can do things on a small scale with hundreds of millions of dollars that would never scale to tens or hundreds of billions of dollars, and therefore have opportunities to make money that an individual investing into a publicly available fund wouldn't.
Take parking lots in China, for example. A hedge fund can say "hey these are really under priced compared to what they might be in 10 years" and run lots of data to show the most under-priced lots. They can spend $50 million dollars on these lots and make ridiculous returns at relatively little risk. However, this same strategy wouldn't work with millions of investors cumulatively investing trillions of dollars. There aren't enough parking lots to go around.
Also, hedge funds are not black boxes. They communicate to their investors what their strategies are and their feedback on how strategies are progressing. Most investors can even say "Hey I want you to use my funds mostly on X" even if your returns are based on the entire fund's portfolio.
That would be one theory as to the interior of the black box, I imagine, in more profitable cases.
* stays away from the pressure to be "with it" every quarter
* stays away from stuff that everyone is talking about
* stays away from short term thinking (like real time datasets)
* stays away from statistical artefacts and spurious relations (aka “huge amounts of data”)
* stays away from stuff where they don't understand the basic business models
* stays away from stuff that is built on promises
* stays away from mostly all hedging, other than paying the proverbial 50c for a dollar
* stays away from diversification "just because" (looks at each individual investment on its own merits)
* stays away from arbitrary limitations on asset types or sectors
* stays away from short selling (or situations where you can loose more than what you put in)
* stays away from giving or taking tips on individual investments
* even stays away from feeling they have to kick ass every quarter (if you just can't find anything good... do nothing)
* instead just focuses on not loosing big quantities of his/her own money
* tries to keep costs down (less data, less trading, no hedging, low fees, less dealing with currency exchange)
* doesn't worry about volatility or even enjoys it
* has a few large winners and then some smaller potential winners
That may exclude most if not all funds, hedged or otherwise.
Also: in my experience every 19 year old and his dog now tend to consider themselves "macro traders". It’s an indication of how extremely financialized the entire world has become since the 80s. That in itself bodes ill for the 2 and 20 crowd.
* stays away from stuff everyone else is talking about --> the big hits only come from things that everyone eventually 'talks about'. So you must be aware of this dynamic. You don't want to ignore the herd - you want to be just ahead of it. Ergo - you have to understand herd dynamics.
* stays away from hedging - 'hedging' is still used often, and it's an important part of risk mitigation and execution strategy. Anyone that ignores herding is ignoring an essential tool that they can use
* stays away from diversification - same as previous: financial diversification is another essential tool.
* arbitrary limitations - no investor makes 'arbitrary' decisions. They stay away from certain sectors for a reason: they don't understand it, it's risky, there are geopolitical issues they can't control etc.
* tries to keep costs down - uh ... keeping costs down is what every company should aspire to do. In fact - if a fund can get rid of 1/2 it's staff through automation, well, you could make more money depending on how the fees are structured
* doesn't worry about volatility - no - you definitely want them to worry about volatility as it's an essential financial characteristic of the market and means a lot. If your strategy is to invest in cheap blue-chips that pay nice dividends because other investors are not paying attention ... well, volatility is bad.
Here's the key: Investing is not really investing. It's mostly gambling - in the sense that it's a zero-sum game, played against other players. It's more like poker.
You don't win at poker just by playing smart cards. You win at poker by understanding other players predictable behaviour, ie understanding the market, as it is driven by other players.
Though markets do grow and there are some 'bonus surpluses' for everyone, most firms do not win off this - they can only win if someone else loses.
* Dealing with risk: hedging and diversification are expensive in more than 1 way. An investor can manage risk with cruder and cheaper means. E.g. by taking out the original investment after the first ~100% in capital gains. Or quickly cutting companies that start violating your initial criteria. Or limiting yourself to trampled paper that hides a beautiful earning machine. Or most important of all: doing nothing in case you can’t find that kind of trampled paper.
* Wrt risk: I guess periodically holding a huge war chest of cash is the only “diversification” I can approve of.
* Many funds and portfolios are built around arbitrary criteria. By which I mean any criteria that have nothing to do with predictability of earnings and low prices for each individual position (when talking about stocks).
* Volatility is irrelevant. Actually, if you have the tiniest bit of patience and a decent stomach, volatility is awesome. I’m happy if I can pay $1 dollar for a well run company that makes 0.25 dollars in yearly profits. I’m happier if it’s an illiquid company and one beautiful day my fishing order for $0.75 dollars gets filled. Often, companies are more volatile when they’re down, so I even feel confident to say that volatility can do wonders for your performance.
I don’t think proper investing is anything like gambling and I’m pretty sure you’re not playing a zero sum game.
Trading on the other hand is a zero sum game. That’s one reason to not be bullish on any given guy who trades without working for Rentec & co.
If your going to try and predict human behavior your better off using that when buying stock. AKA if you know the iPhone is going to win then buy Apple. Or if you bought Dell at IPO that's 500x returns over 12 years.
The hedge fund says, let's convert all your earnings that should be taxed at the short term gains rate and convert them to long-term capital gains!
The hedge fund takes two well-correlated stocks, let's say Coke and Pepsi. They make a hedge going long Coke and short Pepsi. The hedge doesn't make or lose money, but you engineer the hedge so that you hold your long Coke shares 366 days (long-term). You sell your Pepsi shares after 364 days (short-term).
You haven't made any money, but you've engineered short-term capital losses and long-term capital gains. Of course you've created your hedge such that your short-term losses offset your business' short-term gains. Now your profits are in the long-term Coke stock, and rather than paying a 50% marginal tax rate, you pay 20%.
Yay hedge funds!
i think you need to brush up on hedge funds and investment management generally.
That said, we also sell to investment banks, insurance companies, PR firms etc. I'm certainly not an entirely unbiased outsider, but our book is relatively balanced, as it were!
Thanks for reading anyway :)
i.e. a waste of human potential.
Obviously there are side benefits: market liquidity, rational pricing, 'market making' for specific activities, the ability to allocate resources in more exotic ways etc. but by enlarge it doesn't look good.
It'd be nice to see more opportunity in growing the pie rather than fighting for the same pieces.
We really feel there's a lot of power to use the profit making incentive that drives these firms to generate real-world value, and that the main driver of that has to be tying trading decisions more closely to true human value by giving the industry better real-world information (and potentially sensible regulation).
Hopefully, we can help in some small way, but I think we still need to do a lot of work to understand the incentive mechanisms of the industry better.
If you want to subscribe I'll leave a note and let you know particularly when something on that topic comes up.
[1] http://www.krzana.com/blog/the-future-of-financial-analysis
Because over any time period, some strategies are winners, some are losers.
> By the 90s, hedge funds were back, this time capitalising on advances in sheer computing power that permitted real-time pricing of instruments in volumes never previously possible. By introducing more and more complex derivatives and so increasing the difficulty of pricing the market, hedge funds managed to maintain this source of alpha almost until 2000.
There are very few funds who make a living pricing complex derivatives. I used to work in a couple of funds that traded derivatives, and quite often we had to explain to people what volatility trading was. Generally, the more complex it is, the more the market maker will charge you in spread for trading it.
It's also not computing power that allows you to make money trading them. A few numerical PDE solvers do not take a huge amount of computing power (or indeed data) to calculate. The people who make money off it are the ones who manage to sell a product to a client at a price the client doesn't understand. I wouldn't use "complex derivatives" as speculation vehicles ("I'm bullish/bearish -> trade") in themselves.
> Even as the market caught up and the potential for alpha withered for hedge funds in the early 2000s, these newly-technically-savvy funds shifted their focus to speed; driving in the era of the hyper-successful HFT firm that drew massive, riskless profits from the sheer speed at which they could capitalise on arbitrage opportunities.
HFT firms are not hedge funds. I'm sitting in the offices of one right this minute, writing code for a strategy. It's not something outside people can invest in. I wouldn't say the profits are riskless either, they're just not traditional risks that you list in a finance course.
> The winners in this market will require many of the skills that have been required before - deep market understanding, strong technical competence and grounded, balanced leadership - but they will also require a new skill; the ability to acquire, make sense of and apply these new data sets.
Gibberish. You need to know what you needed to know, but also to be open to new situations?
There's no discussion here of how various styles generate their alpha. What do macro guys do? Surely not complex derivatives and HFT? What about special situations? And activists?
