Educamate me on Hedge Funds

[Z-man]

Want to know the risks, ROI's...etc. of this volatile market in our current economic situation. These days, with the market being so up and down, I wonder if the strategic of borrowing on margin, short sales, high risk, and especially lack of regulation make this market desireable or not-so-desirable?

What's the difference between alpha and beta investments?

Thanks,
-Z-man.

[pwd72s]

If it's money you can toss over a bridge, you might as well toss it into a hedge fund.

[911Freak]

Well done Shadetree930, very good explantion. Took the words right out of my mouth.

When I was putting my 1st investment group together in 04 several of the guys asked about Hedgefunds and our accessbility to them. They lost interest once they realized the minimum investment was 500k and vested of 1mm+, oh and they didn't like the fees at 2/20.

I had a buddy who ran one in Santa Monica a few years ago (can't remember the name off hand) but the guy was a stressed out head case. He'd lose 20mm in a few hours like it was nothing! I'll give him credit though, he'd make twice that on more then a few occasions. All in a day of trading...

Carry on!

[jyl]

If you don't have $250K or more, you won't be able to invest in a hedge fund anyway. And $250K won't get you into the big/best ones, not close. There are "fund of funds" that you could look into, but they have minimums too.

The hedge fund world is complex. There are funds that:
- Are long/short equity and market neutral
- Are long-short equity and make market bets
- Use leverage or not (most do)
- Are macro funds, betting on overall country indicies, currencies, etc
- Are fixed income or convertible debt focused
- Are event-driven, usually M&A
- Use quantitative systems to varying degrees
- Focus on specific markets, sectors, commodities, ETFs, etc
- Are activist funds
- On and on

It is difficult to get true performance data for hedge funds, because they report performance only voluntarily, so the data has a major survivorship bias. When a fund's performance goes bad, they stop reporting, and if it stays bad, they shut the fund down and start another one. Actual performance is lower than reported, for the industry as a whole, and performance varies hugely between funds, types of funds, and time frame.

[legion]

To add to what has been said...

I had a professor in college that ran a hedge fund. It's my understanding that you have to bring A LOT of money to the table. Hedge fund managers are extremely secretive about their particular strategies, so don't expect straight answers on exactly what they are doing with your money.

It's also not unusual for hedge funds to go belly up and lose everything. In the pursuit of the highest returns, there is the highest risk. Sometimes they simply make bad bets. Most of them attempt to employ innovative strategies, and if their strategies become known, the market comes to expect their moves, which eliminates the ability to profit. For example, once upon a time arbitraging could yield tremendous returns, but know that the strategy is known, the prices of various commodities and stocks in different currencies tend to reflect the buying power of that currency--their isn't much room for profit anymore.

Finally, even if you have $250k that you can throw into a hedge fund, you probably shouldn't. Your investments should be diversified. You should have a solid base of low-risk investments that make up the bulk of your portfolio. Next, you should have fewer moderate-risk investments, and finally, a capstone of high-risk investments. If you're 21 and fresh out of college, you can make that high risk part maybe 25%. If you are close to retirement, it should be 0%. Making some guesses about your age Z-man, I'd put you in the 5% - 10% category. That means if you have $250 to throw in a hedge fund, you better have a total portfolio of at least $2.5 million.

[Jagshund]

My wife and I took this step about two years back. We filled out a mound of paperwork intended to deduce just how much risk we were willing to take with the money. In regards to the secrecy issues, I completely agree. Some of it is kind of loopy- the woman handling our account was very clear that they only accepted new people who had been referred by existing account holders and our information is pretty limited to knowledge of sectors and degrees of risk that are being taken.

[jyl]

The hedge fund business is somewhat odd. I know lots of people at hedge funds. Their average time at each job is about 2 years. Supposedly their moves are never due to poor performance, how credible do you think that is?

When hedge funds started to take off, about 10 years ago, the hedge funds were small and nimble and could play against the herd, aka the big institutional and mutual long-only funds.

Now hedge funds, and prop desks, and high-speed traders, dominate the trading volume. The hedge funds are playing against each other, they are the herd in trading volume terms. When you check the top holders of the types of stocks that are hedge fund long favorites, you'll often see 3 or 4 hedge funds in the top 10 holders. When a stock becomes a favorite short of the hedgies, you'll see short interest equal to >10 days trading volume, which means very crowded shorts. When the hedge funds are crowded together like that, their opportunities for profit are diminished.

I've read some finance journal articles which purport to show that you can approximately replicate the average hedge fund performance (these are long-short equity funds) using long-only mutual funds and short index positions, at far lower cost.