7 ms·

I'm bullish on hedge funds

41 points by gearhart 10y ago

seibelj 10y ago
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.
- eloff 10y ago
  > 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.
  - mathattack 10y ago
    As individuals we are much better off with passive indices.
  - mathattack 10y ago
    As individuals we are much better off with passive indices.
  - tedunangst 10y ago
    In a down market, an index ETF loses money.
  - JamesLeonis 10y ago
    "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.
    - hkmurakami 10y ago
      >Put another way, Startups are just narrowly defined hedge funds. 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
    - jazzyk 10y ago
      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).
- tomp 10y ago
  > 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.
  - uptown 10y ago
    > 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.
  - gergles 10y ago
    > 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.
    - sseveran 10y ago
- Aelinsaar 10y ago
  https://dummr.files.wordpress.com/2011/08/130661-strip-zoom.gif 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.
- whamlastxmas 10y ago
  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.
inthewoods 10y ago
I don't know why anyone is bullish on hedge funds just based on their numbers. Bottomline, there will always be successful hedge funds, but your chance of identifying the winners before hand is challenging to say the least. Add their costs and "heads I win, tails you lose" fee structure and I'm really not interested.
YPCrumble 10y ago
What hedge funds are really good at is creating a tax strategy for the rich. Let's say you have a business and you want to pay less tax. You talk to a hedge fund. 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!
- lintiness 10y ago
  so you buy this fund, have no market exposure, have some correlation issues, pay tons of fees, and make nothing? i think you need to brush up on hedge funds and investment management generally.
- HappyTypist 10y ago
  This doesn't actually happen. Tax avoidance is all about related party transactions these days, and there are more efficient ways to convert ST cap gains into LT cap gains.
  - lbotos 10y ago
    as someone fascinated by this but outside of that world, can you elaborate?
- soVeryTired 10y ago
  Whether or not you approve of hedge funds, they don't exist for the sole purpose of helping companies reduce their tax bill. Most companies of significant size can play tax games without the help of a (sometimes expensive) intermediary.
- 10y ago
lintiness 10y ago
hedge funds with less limiting investment "thesis" tend to massively outperform bear markets. long s&p500 index funds (all the rage) has been a great strategy since the last real market downturn (7 years), it won't look so ironclad ingenius when stocks take their inevitable 2 year 30-50% dip.
- jomamaxx 10y ago
  'outperforms' ... over which time period? Because over any time period, some strategies are winners, some are losers.
unknown_apostle 10y ago
I’m bullish on any investor who: * 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.
- ianleeclark 10y ago
  So you're bearish on any investor.
  - deleted 10y ago
    [deleted]
  - blowski 10y ago
    I suspect those filters produce the same quality as grabbing names from a hat, since they are a list of popular but vague aphorisms. Judging each and every investment on its own merits is the only way to succeed.
    - 10y ago
crdoconnor 10y ago
This guy sells products to hedge funds.
- robterrin 10y ago
  +1. Colloquially know as, "talking his own book."
- gearhart 10y ago
  I thought publishing on the company's domain was reasonable disclosure, apologies if I didn't make it clear enough. 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 :)
jomamaxx 10y ago
Sadly, most of the history of hedge funds it would seem relates to winning in 'zero sum games'. 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.
- gearhart 10y ago
  We talk about it a lot in the office and I definitely agree with you. Perhaps I'm naive, but I don't think it needs to be the case though. I sort of touched on it at the end of this [1] but it's something I want to dig deeper into. 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 http://www.krzana.com/blog/the-future-of-financial-analysis
lordnacho 10y ago
Sounds mostly like gibberish to me, sorry to say it. > 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?
chrismealy 10y ago
The point of hedge funds is that the US government will allow very rich people to pay super high fees on poorly regulated investments.

41 points by gearhart 10y ago

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.

eloff 10y ago
> 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.
- mathattack 10y ago
  As individuals we are much better off with passive indices.
- mathattack 10y ago
  As individuals we are much better off with passive indices.
- tedunangst 10y ago
  In a down market, an index ETF loses money.
- JamesLeonis 10y ago
  "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.
  - hkmurakami 10y ago
    >Put another way, Startups are just narrowly defined hedge funds. 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
  - jazzyk 10y ago
    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).
tomp 10y ago
> 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.
- uptown 10y ago
  > 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.
- gergles 10y ago
  > 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.
  - sseveran 10y ago
Aelinsaar 10y ago
https://dummr.files.wordpress.com/2011/08/130661-strip-zoom.gif 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.
whamlastxmas 10y ago
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.

inthewoods 10y ago

I don't know why anyone is bullish on hedge funds just based on their numbers. Bottomline, there will always be successful hedge funds, but your chance of identifying the winners before hand is challenging to say the least. Add their costs and "heads I win, tails you lose" fee structure and I'm really not interested.

YPCrumble 10y ago

What hedge funds are really good at is creating a tax strategy for the rich. Let's say you have a business and you want to pay less tax. You talk to a hedge fund. 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!

lintiness 10y ago
so you buy this fund, have no market exposure, have some correlation issues, pay tons of fees, and make nothing? i think you need to brush up on hedge funds and investment management generally.
HappyTypist 10y ago
This doesn't actually happen. Tax avoidance is all about related party transactions these days, and there are more efficient ways to convert ST cap gains into LT cap gains.
- lbotos 10y ago
  as someone fascinated by this but outside of that world, can you elaborate?
soVeryTired 10y ago
Whether or not you approve of hedge funds, they don't exist for the sole purpose of helping companies reduce their tax bill. Most companies of significant size can play tax games without the help of a (sometimes expensive) intermediary.
10y ago

lintiness 10y ago

hedge funds with less limiting investment "thesis" tend to massively outperform bear markets. long s&p500 index funds (all the rage) has been a great strategy since the last real market downturn (7 years), it won't look so ironclad ingenius when stocks take their inevitable 2 year 30-50% dip.

jomamaxx 10y ago
'outperforms' ... over which time period? Because over any time period, some strategies are winners, some are losers.

unknown_apostle 10y ago

I’m bullish on any investor who: * 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.

ianleeclark 10y ago
So you're bearish on any investor.
- deleted 10y ago
  [deleted]
- blowski 10y ago
  I suspect those filters produce the same quality as grabbing names from a hat, since they are a list of popular but vague aphorisms. Judging each and every investment on its own merits is the only way to succeed.
  - 10y ago

crdoconnor 10y ago

This guy sells products to hedge funds.

robterrin 10y ago
+1. Colloquially know as, "talking his own book."
gearhart 10y ago
I thought publishing on the company's domain was reasonable disclosure, apologies if I didn't make it clear enough. 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 :)

jomamaxx 10y ago

Sadly, most of the history of hedge funds it would seem relates to winning in 'zero sum games'. 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.

gearhart 10y ago
We talk about it a lot in the office and I definitely agree with you. Perhaps I'm naive, but I don't think it needs to be the case though. I sort of touched on it at the end of this [1] but it's something I want to dig deeper into. 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 http://www.krzana.com/blog/the-future-of-financial-analysis

lordnacho 10y ago

Sounds mostly like gibberish to me, sorry to say it. > 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?

chrismealy 10y ago

The point of hedge funds is that the US government will allow very rich people to pay super high fees on poorly regulated investments.