My understanding of a hedge fund is simply an organization that is given the freedom to make any type of investment using any type of strategy they want[0]. They raise millions, and for a set period of time the people who gave them the millions cannot pull it out, allowing them to execute strategies that may not make any money for several years, which is different from a traditional investment organization.
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.
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.
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.
"Winning" is the wrong mode of thought. It's risk/reward. Index funds are low risk low reward, by design. Hedge funds are high risk high reward.
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.
Except that the "high reward" part has been missing in the past several years. Hedge funds have been mostly under-performing (compared to the overall market).
They raise millions, and for a set period of time the people who gave them the millions cannot pull it out, allowing them to execute strategies that may not make any money for several years, which is different from a traditional investment organization
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.
Hedge funds are really just teams of people investing money on behalf of others, without regulatory constraints that most mainstay financial firms have, due to the fact that you have to have a certain net-worth etc. to be able to participate.
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...
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
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.
It's silly to say "hedge funds aren't working out so well right now" because this has always been the case.
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.
Comments
My understanding of a hedge fund is simply an organization that is given the freedom to make any type of investment using any type of strategy they want[0]. They raise millions, and for a set period of time the people who gave them the millions cannot pull it out, allowing them to execute strategies that may not make any money for several years, which is different from a traditional investment organization.
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.
"Winning" is the wrong mode of thought. It's risk/reward. Index funds are low risk low reward, by design. Hedge funds are high risk high reward.
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.
Except that the "high reward" part has been missing in the past several years. Hedge funds have been mostly under-performing (compared to the overall market).
s/Startups/VC Funds
Also, VC Funds are Narrowly defined PE Funds, which are in turn Narrowly defined Hedge Funds [1], which in turn are narrowly defined Money Managers.
[1]a "hedge fu8nd" should be able to mimic a PE Fund if it chose to do so
As individuals we are much better off with passive indices.
In a down market, an index ETF loses money.
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.
Many hedge funds are not able to charge 2% anymore.
Hedge funds are really just teams of people investing money on behalf of others, without regulatory constraints that most mainstay financial firms have, due to the fact that you have to have a certain net-worth etc. to be able to participate.
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.
It's silly to say "hedge funds aren't working out so well right now" because this has always been the case.
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.
https://dummr.files.wordpress.com/2011/08/130661-strip-zoom....
That would be one theory as to the interior of the black box, I imagine, in more profitable cases.