I share the epic sagas of Reddit’s Wall Street Bets and Michael Burry’s hedge fund to explain what hedge funds are, who they’re for, what strategies they use, the purpose they serve, and what their infamous fee structures are.
In 2021, we’ve gained new pop culture terms like diamond hands and HODL learned a lot about retail investors on Wall Street Bets on Reddit going up against certain “bad” hedge funds that were shorting GameStop and AMC. Cautionary tales abound!
Watch my “GameStop Epic Saga of Redditors vs Wall Street: The Legend of Roaring Kitty” video to learn more of what happened in Winter 2021.
Dr. Michael Burry is a doctor turned hedge fund manager who made correct bets in shorting mortgage backed securities to make huge profits in his Scion Capital hedge fund during the Great Financial Crisis when the housing bubble burst.
I know that 13-F fillings show funds’ holdings, but they don’t show what securities that funds might be shorting, and we only learn about them through other sources.
We retail investors want similar goals that hedge funds (HF) strive for, like trying to have consistent and above average rates of return on assets, managing investing risks, and having enough diversification. But in the hedge fund universe, they have so many more and professional tools to use and they have access to invest in a bigger universe of assets and financial instruments like derivatives.
A Hedge Fund is an actively managed alternative investment fund using pooled funds from accredited investors to try to achieve “excess returns” (aka alpha).
Alfred Winslow Jones, a writer and sociologist, established the first HF in 1949.
“Hedge” became this type of fund’s name when A.W. Jones was trying to minimize the investment risks of holding stock for the long term by selling other stocks short in the short term. AKA the classic long/short equities model. I share a basic example.
The use of leverage or borrowed money can help amplify returns or lead to ruin because you can significantly increase returns on more invested money or lose that much more if things go wrong.
Worldwide Assets Under Management (AUM) in 2020: $3.8 Trillion with anywhere from 10,000 to 15,000 hedge funds in existence. Hedge fund performance is judged by either absolute return (e.g. 15%) or relative return (e.g. 3% above the S&P 500).
Accredited investors (aka “sophisticated investors”) include:
-High net worth individuals with $200K annual income for the past 2 years or a net worth of $1M+, excluding their primary residence value.
-Institutional investors such as public and corporate pension funds, charitable foundations, non-profit organizations, university endowment funds, family offices, central banks, and foreign governments.
Institutions partner with HFs with the aim of generating returns that fund retiree benefits, provide university scholarships and fund research, and help the missions of community foundations and non-profit organizations.
Since Hedge Funds are less regulated by the US Securities and Exchange Commission (SEC) than mutual funds or ETFs, HFs have the freedom to use different investment strategies often employing leverage and they include equity, relative value, global macro, event-driven, and many more that can also be multi-strategy combos.
Hedge funds’ classic fee structure is known as 2 and 20 where the general partner or hedge fund manager gets 2% asset management fee (often regardless of performance) and 20% performance/incentive fee on profits (sometimes with a hurdle rate applied).
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If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.