Hedge Funds: Everything You Need to Know

Time to review the hedge fund universe. [The Rude Awakening] July 14, 2023 [WEBSITE]( | [UNSUBSCRIBE]( Hedge Funds: Everything You Need to Know - I got a good question over the weekend, so I thought I’d tackle it this morning. - Hedge funds, warts and all, are here to stay. - What are they?How do they operate? Why are they sold to clients? [“A $608 credit has been applied to your account.]( [Please click here to learn how to claim it.]( — Customer Service, Paradigm Press [Click Here To Learn More]( [Sean Ring] SEAN RING Happy Friday! I’m going to recycle an important Rude from nearly two years ago. The topic is hedge funds. I’ve broken them down by strategy. You’ll have a better idea of what they’re trying to accomplish… and perhaps why they’re failing badly at the moment to capture the elusive “alpha.” Alpha is the return above the benchmark the hedge fund uses to measure its performance. Enjoy! What are alternative investments? Before we get into hedge funds, let’s complete a schematic of the alternative investment universe. It’s pretty simple. Alternative investments are, in alphabetical order, commodities, hedge funds, infrastructure, private equity, and real estate. Only high net worth individuals (HNWIs), ultra-high net worth individuals (UHNWIs), and financial institutions such as pension funds, sovereign wealth funds, insurance companies, and endowment funds invest in this asset class. (Except real estate, of course.) Why do private bankers sell hedge funds to their clients? Rich people have rich people problems. Those problems are so much better than poor people’s problems. But they are problems, nonetheless. Those problems are portfolio management, tax liabilities, succession/estate planning, philanthropy, and asset protection. From a portfolio management perspective, hedge funds make a lot of sense. In theory, hedge funds enable investors to increase their returns without increasing risk. However, prices are still rising. Just slower than they once were. [SJN] Credit: TheStreet.com Does this always happen? Of course not. Of the 10,000 hedge funds in existence, only the upper quartile of hedge funds are worth investing in. The rest are trash. [Urgent Notice From Paradigm CIO Zach Scheidt!]( [Click here to learn more]( Hi, Zach Scheidt here… I’m the Chief Income Officer at Paradigm Press. With inflation raging (and showing no signs of coming to an end any time soon), almost everyone in America is feeling the pain in a big way. Which is why, several months ago, I set out on a big mission… my goal was to create a [complete, step-by-step plan to surviving and beating inflation]( one that anyone could take advantage of. Today, after hundreds of hours of research, I’m revealing all of my findings. [Simply click here now to see how to survive America’s deadly inflation crisis](. [Click Here To Learn More]( What are hedge funds? From the [July 8th edition of the]( When Alfred Winslow Jones, an Australian who’d partied with Hemingway and Fitzgerald in Paris, finally moved to New York in 1949, he started his hedge fund. The Investment Company Act of 1940 stipulates that you must register it with the SEC if you have a fund with more than 100 investors. He thought, “I’ll just get 99 or fewer wealthy people, so I don’t have to register.” Was Jones’s hesitance to register for some nefarious reason? No. Registered funds are not allowed to short the market. Jones thought shorting some stocks was an intelligent hedge against being long some stocks. Hence, Jones wanted a “hedged fund.” Of course, Americans love nothing more than murdering the Queen’s English, so they dropped the “d” and started calling those funds “hedge funds.” Jones’s fund is the earliest example of an equity long-short hedge fund, still the largest class of hedge funds in existence. In short, hedge funds are lightly regulated, open-ended investment schemes that invest in the market using different methods than retail or long-only investors. Hedge funds can short the market and leverage their fund by multiples, neither of which long-only funds can do. Hedge funds may also use derivatives such as futures, options, and swaps to express their market views. How do they operate? Hedge funds require a large deposit from investors. The well-known and most renowned may charge a $5 million initial investment. Some may charge only $100,000. Private banks also pool HWNI money under the bank’s name to lower the entry investment. Hedge funds then charge “2-20.” That’s 2% on the year-end assets under management (AUM) and 20% on the fund’s performance. For example, if a fund grew over one year from $80 million to $100 million, the fees would be as follows: 2% x $100 million = $2 million AUM fee 20% x $20 million = $4 million performance fee That’s a total fee of $6 million. This is a simple example. Some funds charge less, and some charge more. Also, keep in mind that a “high watermark” will be in effect. So if our fund drops down to $80 million the following year, it can’t charge performance until it goes back over $100 million again. This leads to some unethical fund managers closing down their funds and reopening the following year—dirtbags. What are the different types of strategies? Below is a schematic of hedge fund styles. There are three big groups: high to low market exposure and nine classes below them. [SJN] Credit: Alpha Development Opportunistic These directional strategies take a leveraged view on market trends, currencies, or other market-based opportunities. Long/Short Like Alfred Winslow Jones’s hedge fund, this one is long the stocks it likes (underpriced, in its view) and short the stocks it doesn’t like (overpriced, in its opinion). Usually, they are net long. Global Macro These funds are based on interpreting significant macroeconomic events on a national, regional, and global scale. Most notably, famous hedge funds such as Bridgewater, Brevan Howard, and Tudor Fund Management are built on this strategy. The main strategies involve currencies, rates, and stock indexes. CTAs Sometimes files under global macro, commodity trading advisors (CTAs) use futures contracts to achieve their trading objectives. Systematic and discretionary trading are two of the strategies CTAs use. Systematic trading refers to putting all the fund manager’s knowledge into an algorithm and letting the computer take care of the trading. Dunn Capital is notable for this style. Discretionary trading lets the fund manager decide what to trade after reviewing his research. That is, trades are made at the manager’s discretion. Relative Value A relative value fund is an actively managed hedge fund that seeks to profit from temporary differences in the prices of related securities. Market Neutral Regardless of an upward or downward market environment, market-neutral funds aim to profit through paired long and short positions or derivatives. These funds can mitigate market risk as they seek to generate positive returns in all market environments. They aim to eliminate beta (or market risk) and profit from their excellent stock-picking skills (alpha). Convertible Arbitrage Convertible arbitrage involves taking a long position in a convertible bond and a short position in its underlying stock simultaneously. The idea is to capture the pricing difference between the convertible bond (or preferred stock) and the underlying common stock. Capital Structure Arbitrage Capital structure arbitrage refers to strategies hedge funds use to take advantage of the relative mispricing across different security classes (both debt and equity) issued by the same company. Fixed Income Arbitrage Fixed income arbitrage is an investment strategy that aims to profit from the minor differences in interest rates between fixed income securities. When using a fixed-income arbitrage strategy, the investor assumes opposing positions (long-short) in the market while limiting interest rate risk. Event-Driven An event-driven strategy attempts to take advantage of temporary stock mispricing, which can occur before or after a corporate event. Hedge funds use it because the method requires the expertise to analyze corporate events for successful execution. Examples of corporate events include restructurings, mergers/acquisitions, bankruptcy, and spinoffs. Merger Arbitrage Merger arbitrage involves exploiting market inefficiencies before or after a merger or acquisition. Merger arbitrage traders focus on the probability of the deal being approved and how long it will take to finalize it. Since there is a probability the merger may not be approved, merger arbitrage carries some risk. Distressed Distressed debt trading involves purchasing bonds that are trading at a distressed level in anticipation of reselling them over a relatively short period at a higher valuation, generating a profit. Wrap Up And there you have it—a 1,200-word introduction to hedge funds. I hope you find it helpful to navigate through the investing world or the business newspapers. Have a great day! All the best, [Sean Ring] Sean Ring Editor, Rude Awakening Twitter: [@seaniechaos]( In Case You Missed It… The Original Leftists [Sean Ring] SEAN RING Good morning Reader, Happy Thursday! Tomorrow is Bastille Day. And with all the recent trouble in France, it’s interesting to revisit the beginning of communism. They’re not communists there, you say? Perhaps not. But one bright historian called the French Revolution the “Proto-Communist Revolution.” Didn’t Marx and Engels start it all? Nope. They just wrote those stupid ideas down. But thanks to this historian of fantastic ability and insight, we know that the French Revolution was nothing like the American Revolution: it was the beginning of the downfall of The West. Paris 2000 I stood at the top of the Eiffel Tower, marveling at the French fighter jets flying over the path of the Champs Elysees. It was July 14, 2000, and I had no idea I had booked my vacation on their holiday. Moreover, I didn’t realize it until I somehow managed to ascend to the top of the Eiffel Tower. I didn’t mail my mother flowers that year, so I thought a call would suffice. I grabbed my Nokia and dialed New Joisey, where my parents still lived. My mother answered the phone. “Happy Birthday, Mom!” “Thanks, Seanie!” We chatted and then I told her where I was. She heard the jet engines scream overhead. It was a nice moment. (Mom’s not much of a traveler, so she didn’t mind not being there.) I thought it a crazy coincidence that my mother’s birthday fell on Bastille Day. It wasn’t until I read about Erik von Kuehnelt-Leddihn that I thought it unfortunate. “The World’s Most Fascinating Man” You must be something special for an intellect like William F. Buckley to call you that. Buckley also called him "A Walking Book of Knowledge." Kuehnelt-Leddihn had an encyclopedic knowledge of the humanities and was a polyglot. He was able to speak eight languages and read eleven others. Kuehnelt-Leddihn argued that majority rule in democracies is a threat to individual liberties. He declared himself a monarchist and an enemy of all forms of totalitarianism. However, he also supported what he defined as "non-democratic republics," such as Switzerland and the early United States. He was unabashedly Catholic and Conservative. Moving to America after World War I, he taught at Georgetown University, Saint Peter’s College, Fordham University, and Chestnut Hill College. Kuehnelt-Leddihn [resettled in his native Austria in 1947]( and devoted his time to alternating periods of studying, traveling, writing, and lecturing. He was a columnist for the National Review for 35 years. What he says about the French Revolution is shocking and refreshing. [“Godfather Of AI” Reveals Stunning Prediction]( [Click here to learn more]( He’s a 35-year AI veteran who has worked closely on AI technology for decades… - In 1988, the National Science Foundation funded him to build an AI chess program. - He’s written and published academic papers on AI. - And he’s used AI to trade stocks as early as 2001. [But today, he’s stepping forward with a critical prediction that he says every investor needs to hear.]( Whatever you do, I’m urging you to not invest a single dime into AI technology until you see this man’s warning. [Click here for details.]( [Click Here To Learn More]( But First, The Original Leftists The first Leftists were a group of newly elected representatives to the National Constituent Assembly at the beginning of the French Revolution in 1789. They were called "Leftists" simply because they sat on the left side of the French Assembly. Shockingly, the original Leftists wanted to abolish government controls over industry, trade, and the professions. They wanted wages, prices, and profits to be determined by competition in a free market. They stood for freeing their economy from central planning. Perhaps most surprisingly, they wanted to remove the government-guaranteed special privileges of guilds, unions, and associations whose members could set the price of their product above what it would be in a free market. Funnily enough, the Rightists wanted a highly centralized national government, special laws and privileges for unions and various other groups and classes, government-run economic monopolies in various necessities of life, and government controls over prices, production, and distribution. You know, like most of today’s Republicans. (Ouch…) The Leftists held power for two years with a small majority. To their great credit, they pushed most of their program through. But before they completed it, a violent minority from their own ranks — the revolutionary Jacobins — took over. Head Jacobin and downright evil bastard Maximilien Robespierre, the “spokesman for the people,” first said that the division of the powers of government was a good thing when it diminished the king's authority. But when Robespierre became the leader, that power belonged to the people, and he chose to consolidate it… predictably. And so began the Reign of Terror. This is what led Kuehnelt-Leddihn to write: First of all, one has to bear in mind that 1789 did not lead necessarily and inevitably to 1792 and to the rise of totalitarianism in Europe and later in all other quarters of the globe. Later Lord Acton, Alexis de Tocqueville, Philippe Sagnac, Georg Jellinek, and Felix have emphasized the American roots of the French Revolution but also insisted that the ideas prevailing in America at the time of the War of Independence had been grossly misinterpreted by the French: They assumed a new meaning and, when transplanted in French soil, degenerated rapidly. Many Americans, fresh from creating their own country, were horrified by what happened in France. John Adams was chief among them. In a letter, he wrote to Benjamin Rush in 1811: Have I not been employed in mischief all my days? Did not the American Revolution produce all the calamities and desolation to the human race and the whole globe ever since? I meant well, however. My conscience was clear as a crystal glass, without scruple or doubt. I was borne by an irresistible sense of duty. God prospered our labors, and, awful, dreadful, and deplorable as the consequences have been, I cannot but hope that the ultimate good of the world, of the human race, and of our beloved country, is intended and will be accomplished by it. And for those who still cannot understand why “democracy” has no mention in the US Constitution, Adams wrote, "Napoleon and all his generals were but creatures of democracy." Kuehnelt-Leddihn included these gems in his chapter on the French Revolution in his fabulous book Leftism. Needless to say, children should belong to the state, a demand that will always be raised by leftists who have an innate hatred for the family as an "individualistic" group that tries to separate itself as an independent cell within the state and society. Voltaire was certainly not an ardent republican, nor was he a democrat. His ideal was a constitutional monarchy headed by a roi sage, Plato's philosopher-king. So was Diderot's. Voltaire wrote of the republic that it represented a social order leading to tyranny. "Independent of my love for freedom," he wrote, "I still would prefer to live under a lion's paw than under the teeth of a thousand rats who are my fellow citizens.” It’s fascinating that the French celebrate this day, even though the Bastille was already condemned and ready to be sold by the government for a real estate project. Hilariously, when the “storming” actually happened, Kuehnelt-Leddihn writes: The Governor of the Bastille, M. de Launay, an enlightened liberal, had a tiny garrison of Swiss and some invalid veterans at his disposal when the mob finally gathered around the building on July 14: He offered only token resistance. The delegates of the Town Hall and two appointees of the mob were received and were invited to join the governor at his meals. In the meantime the drawbridge of the outer court was let down and guns were directed at the inner court. The soldiers, sensing that they had no commander willing to take the responsibility, surrendered. The surprise came when the "victors'' found only seven prisoners. Four were forgers who quickly decamped, two were insane (they had been there only for observation), and one was a dissolute young man of noble descent who considered himself the real hero of the day: he harangued the people with revolutionary phrases. Much ado about nothing, methinks. The French Revolution was the template, not for freedom reigning, but for totalitarian revolutions worldwide. It was a genuine disaster, which led Kuehnelt-Leddihn to write: For the average person, all problems date to World War II; for the more informed, to World War I; for the genuine historian, to the French Revolution. Keep that in mind when someone tries to compare July 4th to July 14th. They’re clearly misinformed. But with all that said…. “Happy Birthday, Mom!” All the best, [Sean Ring] Sean Ring Contributing Editor, The Morning Reckoning feedback@dailyreckoning.com Twitter: [@seaniechaos]( [Paradigm]( ☰ ⊗ [ARCHIVE]( [ABOUT]( [Contact Us]( © 2023 Paradigm Press, LLC. 808 Saint Paul Street, Baltimore MD 21202. By submitting your email address, you consent to Paradigm Press, LLC. delivering daily email issues and advertisements. 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