Hedge Funds Keys, Lessons, Secrets

By pjain      Published Dec. 7, 2019, 8:48 p.m. in blog Invest   

Hedge fund Lessons and Key success factors

Success and Performance Key Factors

Hedge Fund SECRETS and ILLEGAL success factors Overview

There is a lot of hogwash about Hedge fund secrets

Performance Benchmarking

Master Fund 5yr AUMb Peak SinceInception
Jeff Talpin Element 12%
Tudor 5.4%
Caxton 4.1%
Bridgewater 3.8% $160 b 45%'10, 25%'11 11%
Moore 3.8%
Brevan Howard 2.7% 7 aum=$40b
  • 5yrs 2012-19

Key ways Hedge funds make money

  • usual hedgies fare of government bonds, currencies, commodities and stock indexes."
  • Since 2012+ hedgies have "found it hard to make big profits trading in their usual

BM$ 2 and 20 fees Model very heavy!

Hedge fund firms generally charge management fees of 2% and performance fees that give them 20% of the trading profits.

For every $1 of profit they earn on their client’s account, they get to keep 20 cents. This is called a performance fee. No profits, no performance fees. So a HF manager who turns $100 into $200 gets to keep $20 as compensation. The client gets his or her original $100 back plus the $80 of profit. No profit, no performance fees. Its fairly clear incentive arrangement and aligns interests between manager and client in an unambiguous way.

Hedge funds charge their clients an annual management fee (historically 2%) but the trend in recent years has been for this to decline significantly over time, especially when investors are committing large sums of money to the fund. Passive index funds have fees far smaller eg VTI has unde 0.1%.

However there are all sorts of variations on this 2 and 20 theme.

Tax Exemption of Interest Coverage

Trade Long and SHORT - for all markets

Smart HFs, they can benefit and make money in down markets as well.

  • Normally shorting is risky as CEOs have tricks to make stocks restore or switch fast.

Go Anywhere investing

There are few restrictions on what they can invest in. They are still subject to modern Wall Street regulation that applies to ever trader out there.

However since retail investors are excluded, hedge funds don't have to submit to any of the “bubble wrap” restrictions that the SEC puts on mutual funds and other products meant for retail investors.

Proprietary Information - Legally is Hard - Creating PRIVATE INFO

Hedge funds trade in the gray area of information Information is everything to trading. Knowing more, knowing it quicker, or being the only one to know, will make you money. It’s often the only guaranteed way to try to outsmart the markets.

Hedge funds strive for that edge, certainly the legal one. Every trader does.

Post 2009 liberalizations with less regulation and less observation, hedge funds can do it in a far more aggressive manner.

Hiring the best and the brightest

Some have more PhD’s than many college math or economic departments.

Pay for Private Investigators, Polls

If a country has laws making it illegal to run polls the week prior to elections? Hedge funds will hire their own pollsters for private polls to figure out results long before announcements.

Pay very well - people with connections

The number of former officials and present officials who have hedge-fund ties is staggering. It is almost now considered normal. Leave public service related to politics and finance? Go directly to hedge fund. Do collect large payment.

Use teams of lawyers to skirt Gray Regulation

The rules concerning trading in information, what is legal what is illegal, are notoriously gray. So hedge funds hire teams of lawyers to navigate and at times push right into the gray.

Secret! Even Insider Information

  1. Hedge-fund manager Raj Rajaratnam was one of the VERY FEW convicted of insider trading in 2011.

Secret Edge - NOT fame

The more important you are, the less you need to be liked, and the less you need to be seen.

  1. Hates fame and not looking to be loved Their ability and desire to stay under the radar of the public is a signal of how really important they are. Tip-giving analysts seek fame on TV giving investment advice? Either they are fools who don’t know anything and pretend to know it all, or they're fools who know something and are giving it away for free.

HF masters on the other hand flee from cameras, flee from being interviewed, and certainly flee from ever being on Page Six. Unflattering news, unflattering photos, are either bought with money, or buried via legal action. Steve Cohen has even attempted to buy up the rights to photographs of himself, limiting their availability.

  1. Secrecy is most important! On Wall Street the best HFs seek a secret edge and make profits in the dark. The masters have decades of experience and insight. They can divine the secrets behind the frenzy of blips on the screen, finding the hidden order in randomness, and turning that into gold. 

If you think you have that secret it’s dumb to tell others about it for free. Much better to charge huge fees

Dark Pools for trading secretly

Super-Confident, Aggressive and Rude - helps get customers!

  1. They are AGGRESSIVE and rude - like to be feared. 

or even hated HFs aggressive work behavior is standard on Wall Street. Traders often love to bully other traders. It is almost considered a perk of success. I have so much money; I know the secrets of the universe. I don’t need to bother with things like being polite. 

    On the trading floor Cohen was a voracious, unsentimental monster, working his will, conquering all he saw, and verbally thrashing any employee who made a misstep. - nymag

  2. Supreme confidence inspite of setbacks in day-in-and-out trades Even the best trader loses about 45% of the time, beaten by the markets; random numbers that have no empathy. Taking that beating daily, weekly, monthly, wears on you.

  3. Their arrogance and supreme confidence has the advantage of attracting institutional investors. Sophisticated investors assume hedge funds have an informational edge, either legal or illegal. They're so well connected and so informed, the thinking goes, that they must know something we don't.

HF Environmental Factors Limit Success post 2016

1990s-2015 HFs killed Retail Traders

There was a mass extermination of retail traders since the wild excitement of 2000.

Most hedge funds, CTAs and other professionals, profited during the 1990s and 2000s by ruining retail traders. Trading is a zero-sum game, they used retail counterparties to profit from. Often this was done by front-running, going against the herd or various forms of pump-and-dump.

Often, quant originated trades were passed to the head trader and no one knew what actually happened after that. Many were simply not placed at all - it was subject to trusted traders' discretion.

2016+ Fed Put, Passive investing became Hedge fund killers

For last few years passive investing popularity has rapidly increased.

Many of the new passive investors are the old ruined retail traders who are now trying to breakeven and have their hopes on Fed maintaining a free market put option for them.

Hedge funds’ problems are increasing as passive investing popularity is growing. There are fewer retail counter-parties to profit from.

Law of Large Numbers hurts Quant Model Alpha

These models cannot provide alpha to the tune of billions of dollars; they are useful only to retail quant traders with small accounts.

Trading is a Zero-Sum Game

Trading is a zero-sum game - all profits come from the accounts of OTHER TRADERS who lose money. So you have to beat pretty shrewd competitors.

Trading does not generate any new money; it only redistributes existing money deposited in existing accounts. While inflows and outflows are dynamic, there is no way for someone to make a profit unless someone else loses.

  • Trading is actually a negative-sum game due to trading costs
  • If you get profits, subject to taxation - usually short term higher rates.
  • Trading is useful as a mechanism for price discovery in a free market.
  • Long Term Market is smart
  • In the short term noise, bad-news or insider information can distort values

Creating Alpha is really hard


Make money fast before Feds close you down! Illegality in Hedge Funds

TRADING POWER - High purchasing power is the only true edge in the markets

This is the true edge of some hedge funds. They can move price and profit.


Hedge Fund Sales

Institutional, Pension Funds investing in HFs

It turns out that US public pension plans, in an attempt to have the money necessary to pay the gold-plated final-salary retirement benefits to teachers, police, fireman and other government employees have been shoveling as much money into hedge funds and private equity funds as they can.

Key: Sell Ancient Performance - unlikely to be Repeated

Key REPUTATION is everything to keep AUM

The appearance of being smart that is helping hedge funds like the firm Bridgewater helps retain its clients, despite losses this year from bearish wagers on global interest rates.

Dalio "has an aura akin to that of Warren Buffett or Bill Gross," Bloomberg says, adding that his name has been mentioned more than 9,000 times in the media since his book has been published.

Bridgewater has just become such an institutional name. It’s very hard to get fired for allocating capital to Bridgewater because of who they are and their reputation. - Culbertson

Key: Strong sales force

Bridgewater for instance has about 200 people that oversee client relationships, which amounts to one per every 1.7 investors. The company also publishes daily thoughts about the markets or economies that "investment heads say helps them look smart when they appear before their boards."

Hedge Funds finding hard to attract investors since 2014

Hedge funds are struggling to attract capital and justify their high fees. A well-publicized hedge fund backed by some very big names in the industry closed earlier this month (paywall). Billionaire David Einhorn’s Greenlight Capital has seen its assets under management shrink by more than half, to $5.5 billion, since 2014.


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