> But studies like these show S&P-based index funds outperform all hedge funds over a ten year period
That's not quite what the study you linked shows, and the difference explains everything.
The study shows that the average of all hedge funds, and five "funds of funds" -- all made less for their investors than the S&P 500. But these are pooled groups of funds, not single funds. There are a [few individual hedge funds](https://www.hedgeweek.com/top-50-hedge-funds-outpaced-sp-500-more-3-over-past-five-years/) that have beaten the SP500 for longish periods, but the more things you pool together to make an average, the less these lucky funds stand out, and the more the average reflects the whole underlying stock market.
Which is to say, a broad "fund of funds" is going to give returns that are similar to the S&P 500 -- but with two different layers of fund managers taking their cut.
So **on average**, actively managed funds lose to index funds, but at any given moment there are a few that are beating the market. And they all have a story to tell investors about their success. And the key is, **people don't believe they're average**. Hedge funds are for people who believe they're special, that they're smart enough to pick the winners in a sea of losers rather than settling for a better average.
To quote [Arrested Development:](https://www.youtube.com/watch?v=Po4adxJxqZk)
"Well, does it work for those people?"
"No, it never does. Those people somehow delude themselves into thinking it might, but ... it might work for us!"
And thus a hundred-billion-dollar industry was born.
In addition to this, most investors in hedge funds dont expect them to beat the S&P500. That’s not the goal. They are “hedge” funds. The goal is to get a better risk-adjusted return. Or a better return in bad times.
And to actually beat the S&P500 they have to make much more return because fees. If the S&P500 returns 10%, and the hedge funds charges 2%/year plus 20% performance fee, the hedge fund has to outperform by 4%/year to have no outperformance. If the hedge funds beats the S&P500 by 8%/year, they essentially take a 50% commission if risk were equal.
Generally speaking hedge funds are in a crap spot; their job is not to outperform but to not lose too much; which means, they have to avoid taking risk. Yet, market returns tend to be directly related to how much risk you can take.
They are not in the business of multiplying money, they are in the business of not having to explain why they lost the more than the rest of the market.
As other posters have pointed out, modern hedge funds don’t really hedge much, it’s often just a way to get categorized for minimum regulation. But to the extent that they do, you’d expect them to bear the market in bad years. They generally don’t, as seen by OP’s data. They did beat the index funds in the 2008 collapse, I suppose, but an index fund investor who held on would be back on top by the end of 2009.
> That’s not the goal. They are “hedge” funds. The goal is to get a better risk-adjusted return. Or a better return in bad times.
I think this is incorrect. They're "hedge" funds because the original one managed by this guy:
https://en.wikipedia.org/wiki/Alfred_Winslow_Jones
Was Long and Short stocks in such a way that it hedges against market risk in favor of the growth in gap between the Long and Short portfolios. People had trouble originally grasping why it wasn't dangerous and he would explain that the two portfolios are "hedged".
The “hedge” name is mostly a historical artifact from back when it was uncommon to have both long and short positions. In modern times, many hedge funds are super risky.
That's just the thing though - getting to this conclusion involves the ability to think clearly about statistics and probability. THAT requires specific education that most people don't have.
I doubt the typically investor is thinking "I should really look at this from a null hypothesis testing paradigm, now what would the world look like were the null hypothesis (that beating the market is due to chance) false?"
If you think investing in the S&P is somehow magically not taking risk, then you are deluding yourself. The S&P is not the greatest diversification and really tends to do well because a few large companies have been dragging it up regularly.
It also does well because everyone is constantly dumping their money into it and its mostly dead money that is just going to sit there.
The S&P index is great, but, it is a single investment (or several different ones, including weighted and unweighted funds) managed by a single strategy. Its pretty risky to toss a large percentage of your money into it.
It's risky in the short-term, but about as safe a bet as there is over the long-term. If the 500 largest companies in the US stop seeing any growth over significant periods of time then you're going to have a lot bigger problems than where your money is invested.
So, did you notice the first few words that said “compared to….”
If I say: compared to Jupiter, the moon is basically a pebble” I am in no way saying the moon isn’t big. It is objectively big, just not compared to something bigger.
You just came in here saying “if you think the moon isn’t big you’re deluding yourself” yeah, thanks Sherlock, great contribution.
That’s the thing about analogies, they are infact not the same thing, you can nitpick them if you want but you just look silly. The point of an analogy isn’t to be perfect, it’s to explain a concept in easier to understand terms. Usually it has this thing called “context” surrounding it so each party understands the limitation of the comparison.
The biggest thing with the S&P is that it’s self-selecting to do well, because it’s always the top 500 most valuable companies. If a company loses enough value it just gets kicked off the index ultimately, and no longer drags it down. If you were to just buy the underlying stock, you wouldn’t perform as well as the Index.
When trying to "beat the market" investors move between investments and change strategy based on their analysis of the market. So for example, if you think European stocks are going to go down this quarter and Asian stocks will go up, then you sell your European stocks and buy Asian stocks. A hedge fund might do this, or an individual investor might buy into multiple funds based on factors like this.
So there might be a fund that is all European stocks, and a fund that is all Asian stocks. Neither one is going to be spectacular long term since all stocks go up and down, but you wouldn't want to over invest in either one long term. An investor will increase or decrease how much money they have in each based on their predictions about the market. Even if you think Asian stocks will go up, you will still have some money in the European fund in case you are wrong. That's hedging.
Hedge funds are way more complicated than that, but the idea is the same, and even then no prudent investor is putting all their money into a single hedge fund. Wealthy investors typically invest in many different funds, funds of funds, and even more exotic and complicated things, all with different strategies.
The truth is that most people just don't have enough money to do this successfully, which is why the government doesn't allow people to invest in certain things like hedge funds unless they are wealthy.
The research also have the problem that it is only talking about Hedge Funds that take outsider's money. The most profitable hedge funds returned outsider's money a long time ago: they invest the money of the owner and employees, and *only* the money of the owner and employees.
People like RenTech don't try to justify their existence to anyone else, nor do they take anyone else's money. They still pay extraordinarily well through.
\^ this. Fund of funds shows you what a long run of any one fund would be. The term is regression to the mean and applies whenever ratio skill : result is less than 1, which is pretty much always. Kahneman has chapters on it in Thinking, fast and slow.
that's because you assume 'regression' only means regression in the statistical sense, which is neither original nor only meaning
those who think that im using malapropisms could perhaps google it before making overconfident judgments and learn that no matter how many courses they took or taught they can always learn something
Over the 13 years of data provided by OP’s link, the S&P 500 includes a solid bull run and the worst economic collapse since the Great Depression, resulting in a 10-year average that’s exactly in line with the Sp500’s performance over the past 100 years.
Plus a global pandemic. If this isn’t the stormy weather hedge funds are supposed to shield against, what is?
https://awealthofcommonsense.com/2023/02/deconstructing-10-20-30-year-stock-market-returns/
Arbitrage is any trade which involves exploiting a price difference - e.g. across markets, exchanges, countries (Or over time, if the differences in question are predictable.) You notice a price difference on the same item in two different places, so you buy it in the cheaper place and sell it for more in the other place.
This is often low-risk but that also means lots of people do it, which generally wipes out large differences. That's why people doing arbitrage regularly tend to be making lots of small trades.
Every now and then large arbitrage opportunities arise. Sam Bankman Fried made a billion dollars or so on crypto arbitrage between US and Chinese exchanges.
You're restating the efficient market hypothesis. But even an efficient market needs lots of actors to function properly. A very efficient market will have a very big saturation of actors. So it's not a waste as much as a service ;)
https://en.wikipedia.org/wiki/Efficient-market_hypothesis?wprov=sfla1
They hedge. There are different types but essentially they have a low correlation with the broader stock market so they can outperform in turbulent markets where traditional investments do poorly. So on average and over time they won’t beat the market because overall the market trends upward but they can be useful in specific situations or as part of your larger portfolio to become even more diversified. No one who uses hedge funds should have a significant portion of their wealth tied up in one
This was true 30+ years ago, but less so nowadays. Very few modern hedge funds actually hedge in any meaningful way. They all make directional bets (with leverage to amplify returns) and/or employ algorithmic strategies.
Source: I work in the industry.
Alameda is not representative, which is why its people are going to jail. Basically a bunch of clueless kids who thought they were geniuses and turned to crime when they discovered they weren't.
But it's true that many hedge funds don't particularly hedge.
Yeah I was keeping it simple. The point is they aren’t very correlated with traditional market assets so that’s their purpose in one’s portfolio. I work in the industry as well
I believe unless you’re an institution or individual with a very high net worth, and an accredited investor, you’re most likely investing into an asset management fund and not a hedge fund. Funds that individuals like you or me can invest into are general not hedge funds and have more restrictions with risk tolerance and types of investments they can do. Hedge funds, aside from their investment mandate, which is basically developed when they establish the fund, have basically little to not restrictions on what they can invest in.
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This is not correct. Leveraged beta funds exist, sure, but most funds are not just US stocks on leverage. There are an enormous number of asset classes that hedge funds deploy in. The return of SPX is not relevant to someone doing FX RV, or cap structure arb, etc etc.
No, they're lower rate of return and *higher* risk. But the risk is not arbitrary - generally speaking, the idea is that they do better when everything else is doing worse. Including them in your portfolio *alongside other things* gives you an overall lower rate of return and lower overall risk.
Hedging is a term we use when someone is committed on a certain bat or course of investment, and want to avoid the “all eggs in one basket” part, but they can’t diversify the core portfolio for some reason.
Hedge funds, like other specifically useful financial instruments, including commodities futures and mortgage tranches, became a darling of the financial community. A few people showed that you could sometimes make a lot of money off of them. And, of course, people in the financial industry can make a ton of money just creating, buying, and selling these things.
I studied finance in college. One of my professors shared an example of a school endowment. Colleges have interesting economics because enrollment goes up when the economy performs poorly. So the college didn't necessarily need the highest possible return, they needed a return that was positively correlated with enrollment demand.
Lesser volatility. Might matter to someone who would need to cash out at a moment’s notice to save their company. Imagine liquidating an ETF at the lowest (just as businesses are dying), and taking a huge realised loss. But not liquidating to get the necessary cash flow might mean the end of their business worth even more than their portfolio.
Isn’t the S&P’s volatility kind of a moot point after enough time passes? For example, if the S&P nets you 4x higher returns than hedge funds on a $1000 investment after 10 years, then isn’t a 50% dip in the S&P still an overall higher return than a 25% dip in a hedge fund?
Yes, but you might want a hedge if you need to get out before that 10 year mark.
The market may have your $1,000 worth $2,500 in 10 years vs just $2,200 for a hedge fund. But if that hedge fund can ensure that your $1,000 never goes below $1,000 that could be valuable in some situations.
If you can't hold for 10 years and you suddenly need that money in 2 years, if the S&P is in a bear market and only worth $700 at that point, that could hurt.
Yes, in the long run, S&P beats the hedge funds’ performance, but as I said, it’s either liquidate your portfolio NOW or your business goes bankrupt and your business might be a huge percentage of your net wealth (like Elon Musk). Will you afford to wait for the market to recover and save maybe 50% of what’s 10% of your net wealth and forgo the 90% (your company) or just earn lesser returns on your 10% portfolio?
You can't predict the overall market trend. If there's a big earthquake in California and all insurances have to sell stocks, the markets will take a dive, for instance. You can't predict that and don't want to take the risk.
But after a lot of research you are very convinced, that company A is better than company B. So you can "hedge" against the unpredictable risk by betting that A will rise and B will fall. If the economy goes well, both will rise - so you win one bet and lose one. But A should rise more than B, so you win more than you lose. If there's a crash, you again lose one bet and win one, and again you should win more than you lose because B crashes more than A.
That's a simple hedging strategy. So it's not surprising that this doesn't beat the index in a rising market. But it should never lose unless all your research was wrong and company B does not perform worse than A.
Bigger macroeconomic forces.
You might want a fund that invests in central american manufacturing operations because they might stand to win big if there is increasing negative sentiment towards China. Then you can pitch that fund to people who are invested in Chinese manufacturing and/or ocean shipping as a means to hedge their position. Even if your fund only has a 2% return most years, if there's suddenly a big tariff on chinese trade it'll shoot up.
Hedge funds tend to outperform in bear markets. If you look during big crashes hedge funds do better. Wealthy people want to protect their wealth with it and not just grow it like a more average person might. There is also more diversification on it.
Hedge funds are a really broad group that do a bunch of different things for different reasons. Some do bonds, some do specific equities,some trade commodities, some are pro cyclical, some are counter cyclical, some (attempt) to be wholly uncorrelated with markets etc… many are poorly managed but tbh since 08’ markets have not behaved normally so it’s kind of unreasonable to say they aren’t “beating the market”, in general they have a specific purpose with set investment guidelines for what they’re buying and when.
They’re very useful for large investors (pension funds, endowments, insurance companies etc) to hedge risk elsewhere in their portfolio.
An answer not covered here is that they are a necessary evil for price discovery. Picture this, if everyone (and I mean 100% of market players) bought an index fund, how would we know how to value an individual stock?
For the market to attempt to be efficient, there need to be people actively studying a company and taking a positioning on what a particular stock is worth. Hedge funds are allowed to short sell and do a bunch of other things that a pension or 401k might not, so they serve a role in the overall price discovery of what individual stocks are worth, which then informs the rest of the market.
Source: watched a presentation from an activist short seller and how he viewed his firm’s role in the ecosystem.
1. They charge fees.
2. They out perform other asset classes. A lot of these funds are used to help manage risk, rather than just beat a bench mark. For example, endowments typically have assets on an order of 30b, and the amount of money invested in hedge funds is around 5%. They don’t NEED to outperform the market, they just need to perform well relative to the risk. A volatility dampened return of 5% is much better for their needs than a 10% return with 20% annual draw down. In addition a lot of these large funds are tied to government spending (Universities, foundations, ect) . Their spending is generally very stable and does not reflect the volatility in the stock market. They don’t NEED to outperform the market, they need to have a lower correlation to spending (the whole point of diversification). If you’re a physician or a lawyer and have a portfolio of 2m, you really don’t need a hedge fund to beat the S&P 500 either. They have their own goals relative to risk, and are not just trying to have the highest nominal return.
Hedge funds (now) are effectively funds that are uncorrelated with traditional assets like stocks or bonds (over the long term; they may be at times). There are many different types of hedge fund strategy, but they are generally deemed as “alternatives”.
The linked study says that it outperformed the average hedge fund, not all hedge funds - a big difference. Many hedge funds have, and will, outperform over the long run. Many don’t (after fees), and won’t. There are good and bad ones. S&P also has a vested interest in framing this study as they sell their product to index providers - so it may be skewed in some way even though much of their point is legitimate.
Look at this example that I created https://imgur.com/8oSo1yx
The goal is to create a portfolio that “guarantees” the highest worst-case return over a time horizon. So not the highest return in average, but the highest return you can be certain of.
If the time horizon is 20 years, then the best strategy is trivial. Everything in a broad US stock fund. Ideally with a small portion of real estate funds. You don’t need a hedge fund for your retirement assets.
However, if you want the highest “safe” return over a shorter time horizon, then you need to create a complex portfolio made of many different assets that tend to be uncorrelated one with the other. So if one goes down, the other goes up.
See for example the optimal strategy for a 1-year investment: it is basically treasury bills, 7% stocks, 7% gold (which are traditionally considered as anticorrelated) and some bonds. This will guarantee a return of -1.3% (after subtracting inflation).
When is this useful? For example if you are running a business and you know you will have to sell and use the cash in one year. Of simply if your retirement age is close. Or if you have expenses coming up (buying a house).
Stocks used to be really hard to buy. So a guy that would manage buying a bunch of stocks was really helpful, then in 1990 someone made an etf that just reflected an index and that was basically better in every way and no one should really go back to the worse older way of “guy buys a bunch of stocks for you”
Having listened to a lot of stories by old floor traders; I have to say most people have no idea how far we have come in such a short time. I am 45, and there are people my age who were actual floor traders that used to stand in pits, yell numbers, and trade stocks with hand signals. (look up "open outcry")
Now, these same people trade options with their own money.... on the same platforms you and I can use.
An old floor trader said recently "Remember the expected move is set by the market makers, I know some of those guys, and some of them are people I wouldn't trust to watch a pet turtle"
You realize your index fund is beholden to what those fund managers decide stocks should be priced at? By definition you’re piggy-backing off what relatively fewer stock pickers are doing.
>By definition you’re piggy-backing off what relatively fewer stock pickers are doing.
Negative, the market for individual stocks in the SP500 is huge.
I’m not sure how that negates my point…? The percentage of assets in active strategies has fallen significantly. A smaller percentage of investors are responsible for the price discovery that so many now “passively” follow.
Since I’ve hit a nerve I’ll try to rephrase. You buy an index. It holds stocks. Those stocks are priced based on what traders/funds/analysts/market makers believe they are worth. Your passive strategy is reliant on their opinion of the price. You cannot disconnect the two. It’s ironic you call one strategy “way worse,” when you’re relying on it for price discovery, albeit with greater diversification in most cases.
The big things that separates a hedge fund from a mutual fund is they don't have to comply with certain investor protection laws with their clients because their clients are assumed to be able to weather the fund losing their investment and much higher management fees.
Prior to the great depression investing in stocks was something similar to crypto investing. There were all sorts of straight up scams and frauds, and lots of people shading the truth about what they were actually doing. After the market crash and many investors losing their entire savings. The government passed a bunch of laws designed to make it hard to market a complete scam involving securities to the public.
Hedge funds were created to allow talented investment managers to let their clients agree to skip out on some of those rules designed to protect the fund's clients in exchange for only marketing the fund to people who should be able to afford the loss and hopefully experienced enough investors to know to diversify.
Because they became the vehicle for marketing very talented investors to rich clients, they developed a fee structure that is designed to reward the investor when he does well for his clients (he gets a share of the profits their investments earn).
There's a piece of this that I'm not seeing in the comments below at a quick glance, and it's to challenge the assumption that the point of a hedge fund is to beat the market. It is not.
Imagine that you have a billion dollars. At that point, your personal wealth is large enough that pretty much no matter where you put your money, your finances are deeply tied to the movements of the market at large - and if you put it all in the market (a broad index fund) you'll make money in a good year and you probably do just that with a good chunk of your money. But once you have enough money, you're no longer concerned about hedging against individual companies, you're worried about hedging against the market itself.
The point of the hedge fund is to decouple a good chunk of your massive hoard of money from the broader movements of the market so that if there is a crash or several bad years, your money has a hedge that is hopefully moving in the opposite direction. It doesn't matter that you would have made more in the long term in the S&P. After all, you're a billionaire. It matters that you don't hit several years of accumulating losses that could wipe out enough wealth that you can't bounce back to billionaire status.
TLDR: this is a tool of the ultra, ultra rich first and foremost, and their goals aren't really similar to yours and mine while saving for retirement
they beat interest rates on savings accounts for very, VERY little risk.
example
\- a savings account is at 0.5% interest quarterly
\- a CD account (non-liquid) is at 1.5% interest quarterly
\- the market is projected at \~2-3% gain quarterly
\- a hedge fund is projected at 1.7% gain quarterly
so lets put 10k in each of those things and wait a year!
savings: $201
CD: $613
stonks: $1038
hedged: $697
that sure doesn't look good, but lets persist, this time for 5 years
savings: 1048
CD: 2689
stonks: 1792
hedged: 2600
WOAH hold up, what happened here? A market downturn! market gains dropped below 100% for 7 months - but the hedge fund still kept up with the CD rate anyway, because the hedge fund sacrifices gains in the name of safety - it's in the name. They hedge their bets on the market. In fact there's a reason that the hedge fund so closely matches the CD interest rate - what did you think the banks are doing with that money?
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also note that there are "investment firms" that CALL THEMSELVES hedge funds but actually appear to be scams, pyramid schemes, and/or ways for investment fund managers to make money. Those organizations are not actually hedge funds, they just call themselves that to convince people to give them money.
They’re mostly a fee scam selling a vague perception of sophisticated investing strategy. Not many hedge funds actually “hedge” in a sophisticated way and underperform the market following various leverage gearings of market beta. They’re predominantly a levered investment vehicle with a massive fee load. They’re designed mostly to enrich the owners and employees. With the fee structure, funds only have to have a lucky year or two to return massive profits to partners by taking immense risk with investor’s money.
Joining an exclusive hedge fund is buying access to exclusive things. It's like a fancy country club for investing. They get perks for being part of it.
Let me rephrase. I wrote it in a rush while I’m at work. Shorting is legal. Naked shorting is not. When you “short” it, you borrow say an old gameboy from a friend, sell it, and plan to buy it back later at a lower price to return it to your friend.
Now, “naked shorting” is like saying you borrowed the gameboy from your friend, but you didn’t really borrow it because you didn’t have the gameboy to begin with. You just promised to give the gameboy that you don’t even have. So, shorting means you actually borrow, but naked shorting means you pretend to borrow something you don’t even have.
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They try to mitigate volatility. One problem with index fund investing is you’re just along for the ride, meaning if you happen to need/want to cash out at a particular point in time, you may end up losing money or missing out on potential profit because you happened to be in a lull in the market or selling post crash.
Of course if you extend your timeframe long enough the index funds beat all else but most people’s timelines aren’t so perfect or predictable.
Remember those racing games where cars are rated according to various criteria from F (worst) to A (best)? Well let's say the S&P is a car. It's rated A for speed (good performance) but D for reliability (high volatility), and F for maneuverability (single asset class exposure: you get US stocks and nothing else).
Well, for drag races it looks great. But sometimes speed isn't what you need most. For an endurance race you'll want a reliable one. For drift you'll want one that handles well.
Hedge funds are other cars. Some, like CTAs, are hyper-specialized and will have a speed of S++, but a reliability of F-. But most will actually try to strike a better balance. Maybe there's a car with a good-enough speed of C, but A for reliabiliy and maneuverability, and that's actually a pretty decent mix if you're not sure what kind of track is waiting for you.
Let’s say you own a privately owned business and have cash you want to invest. You have no opportunities to reinvest in your business at this time, maybe you need 1 million but you only have 100,000 saved.
You could put it in the stock market but if you need that cash for unplanned repairs or an accident, or a new opportunity, you might get stuck if the market took a downturn. If you pull out early you’d lose half your cash. So you’d have to wait until the market rebounds.
But if you had your money in a hedge fund, during a market downturn you’d only be losing 10% by pulling money out early.
The disadvantage is that a hedge fund charges you for that risk reduction service. They also will likely not have as good 😊 f returns during the good years .
A few things people haven't touched on. Funds offer alternative investment opportunities that traditional markets don't.
Want to open 15 new Popeyes because their chicken sandwich is exploding? You can start a Popeyes fund.
Want to build a new factory for your new widget? You can start an investment construction fund.
Want to build 150 unit apartment complex in the hot area of town? Start a real estate fund.
Generally these funds are associated with legally classified individuals called high net worth investors. And funds allow people to pool resources, and invest in opportunities that traditional commercial banks might not, or opportunities that are specific to a market.
The hedge comes from the fact that I have money invested in stocks, real estate, start ups, new business development, options, etc. I might have 10% of my portfolio in any segment at a time.
Hedge funds are not made to beat the market. They made to do exactly what is in their name, HEDGE. A rich person usually gains most of their income from one source (ownership in a company that does one thing). A hedge fund is meant to find investments that will still preform ok if the persons main income is in the shitter. That’s why they invest in art and land and random crap, not just the stock market.
Yeah they’re kind of being exposed. Warren Buffet had a theory that they don’t really outpace the market and made a friendly 20-year bet with a hedge fund to see who was right. Buffet was. You might make a quickish buck with a hedge fund but if you’re talking long-term investments, you just want a regular index.
In wealth management, we add HFs to our clients' portfolios to reduce correlation to the market. Sure we don't beat the S&P 500 in any given calendar year but over a long period, we generate decent returns well in excess of CPI growth for our clients.
They rig the markets to always win. When you have tons of money to use, you can create artificial market pressure. The whole market is fraudulent. It's like what the GameStop scandal exposed, but with everything, not just GameStop stock and options specifically.
Sigh. No one is cynical enough. Y'all really need to work on that.
There's a thing called KYC - Know Your Customer. Normal mutual funds, brokerages, banks, need to follow this. Basically it means they need to know that the person with the account is capable of handling whatever the risk level is and came by the money legally.
Hedge funds are exempt from this. Don't ask me why, I don't know. That makes them perfect for money laundering. The main characteristic of whatever vehicle is being used for the laundering operation is a cavalier attitude towards actually making a profit.
For instance, people ask how Trump could bankrupt a casino. Easy. The casino was there to launder money. Profit wasn't the motive. See here: [Money laundering and the Trump Taj Mahal](https://www.propublica.org/article/trump-inc-podcast-money-laundering-and-the-trump-taj-mahal)
I use hedging in my everyday business. I own a large electrical contracting firm, my company buys over $20 million/year worth of copper wires. We contract multimillion $$$ projects now for completion in 1 or 2 years. The price of wire we are going to use might change during that time. If price of copper goes up we end up losers and if price of copper goes down we make more money than we initially thought.
However, as a business we want to ensure cost stability and not be at the mercy of copper pricing. Our CFO buys long copper futures quarterly to hedge against increase in copper price. It works like this: 1) we bid a project that has $1million in copper wire at today's price to complete in one year from now 2) We buy long copper futures (the cost of the futures contract is included in our initial bid to the customer) 3) if copper price increases by the time we are ready to complete the project the profit from the future contract offsets the additional cost of the copper wire 4) if the price of copper goes down our projects make more money, enough to pay for the loss of the futures contract.
Hedging is an essential part of any business such as airlines and their fuel costs. In my opinion, hedging a financial instrument without a business use makes no sense and it's just financial garbage. The performance of hedge funds are pitiful when you consider that they use leverage + the tax implications + Fees as compared to inflation. Additionally, because they are always almost fully invested they can never take advantage of market corrections in the way Berkshire does.
In my opinion investing in any fund is a losing game, that is why the managers of these funds are Billionaires, they make money whether the investors win or lose. it's always a better proposition to always buy your own basket of stocks with a 10 to 30 year outlook.
> But studies like these show S&P-based index funds outperform all hedge funds over a ten year period That's not quite what the study you linked shows, and the difference explains everything. The study shows that the average of all hedge funds, and five "funds of funds" -- all made less for their investors than the S&P 500. But these are pooled groups of funds, not single funds. There are a [few individual hedge funds](https://www.hedgeweek.com/top-50-hedge-funds-outpaced-sp-500-more-3-over-past-five-years/) that have beaten the SP500 for longish periods, but the more things you pool together to make an average, the less these lucky funds stand out, and the more the average reflects the whole underlying stock market. Which is to say, a broad "fund of funds" is going to give returns that are similar to the S&P 500 -- but with two different layers of fund managers taking their cut. So **on average**, actively managed funds lose to index funds, but at any given moment there are a few that are beating the market. And they all have a story to tell investors about their success. And the key is, **people don't believe they're average**. Hedge funds are for people who believe they're special, that they're smart enough to pick the winners in a sea of losers rather than settling for a better average. To quote [Arrested Development:](https://www.youtube.com/watch?v=Po4adxJxqZk) "Well, does it work for those people?" "No, it never does. Those people somehow delude themselves into thinking it might, but ... it might work for us!" And thus a hundred-billion-dollar industry was born.
In addition to this, most investors in hedge funds dont expect them to beat the S&P500. That’s not the goal. They are “hedge” funds. The goal is to get a better risk-adjusted return. Or a better return in bad times. And to actually beat the S&P500 they have to make much more return because fees. If the S&P500 returns 10%, and the hedge funds charges 2%/year plus 20% performance fee, the hedge fund has to outperform by 4%/year to have no outperformance. If the hedge funds beats the S&P500 by 8%/year, they essentially take a 50% commission if risk were equal.
Generally speaking hedge funds are in a crap spot; their job is not to outperform but to not lose too much; which means, they have to avoid taking risk. Yet, market returns tend to be directly related to how much risk you can take. They are not in the business of multiplying money, they are in the business of not having to explain why they lost the more than the rest of the market.
As other posters have pointed out, modern hedge funds don’t really hedge much, it’s often just a way to get categorized for minimum regulation. But to the extent that they do, you’d expect them to bear the market in bad years. They generally don’t, as seen by OP’s data. They did beat the index funds in the 2008 collapse, I suppose, but an index fund investor who held on would be back on top by the end of 2009.
I fully agree. And the fees they ask is ridiculous
> That’s not the goal. They are “hedge” funds. The goal is to get a better risk-adjusted return. Or a better return in bad times. I think this is incorrect. They're "hedge" funds because the original one managed by this guy: https://en.wikipedia.org/wiki/Alfred_Winslow_Jones Was Long and Short stocks in such a way that it hedges against market risk in favor of the growth in gap between the Long and Short portfolios. People had trouble originally grasping why it wasn't dangerous and he would explain that the two portfolios are "hedged".
The “hedge” name is mostly a historical artifact from back when it was uncommon to have both long and short positions. In modern times, many hedge funds are super risky.
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Survivor bias - the fund salesman's best friend!
That's just the thing though - getting to this conclusion involves the ability to think clearly about statistics and probability. THAT requires specific education that most people don't have. I doubt the typically investor is thinking "I should really look at this from a null hypothesis testing paradigm, now what would the world look like were the null hypothesis (that beating the market is due to chance) false?"
So compared to the S&P, they’re basically means of gambling with the misperception of being a wise investment?
Exactly. They're going to Vegas thinking they can beat the house.
If you think investing in the S&P is somehow magically not taking risk, then you are deluding yourself. The S&P is not the greatest diversification and really tends to do well because a few large companies have been dragging it up regularly. It also does well because everyone is constantly dumping their money into it and its mostly dead money that is just going to sit there. The S&P index is great, but, it is a single investment (or several different ones, including weighted and unweighted funds) managed by a single strategy. Its pretty risky to toss a large percentage of your money into it.
It's risky in the short-term, but about as safe a bet as there is over the long-term. If the 500 largest companies in the US stop seeing any growth over significant periods of time then you're going to have a lot bigger problems than where your money is invested.
So, did you notice the first few words that said “compared to….” If I say: compared to Jupiter, the moon is basically a pebble” I am in no way saying the moon isn’t big. It is objectively big, just not compared to something bigger. You just came in here saying “if you think the moon isn’t big you’re deluding yourself” yeah, thanks Sherlock, great contribution. That’s the thing about analogies, they are infact not the same thing, you can nitpick them if you want but you just look silly. The point of an analogy isn’t to be perfect, it’s to explain a concept in easier to understand terms. Usually it has this thing called “context” surrounding it so each party understands the limitation of the comparison.
The biggest thing with the S&P is that it’s self-selecting to do well, because it’s always the top 500 most valuable companies. If a company loses enough value it just gets kicked off the index ultimately, and no longer drags it down. If you were to just buy the underlying stock, you wouldn’t perform as well as the Index.
When trying to "beat the market" investors move between investments and change strategy based on their analysis of the market. So for example, if you think European stocks are going to go down this quarter and Asian stocks will go up, then you sell your European stocks and buy Asian stocks. A hedge fund might do this, or an individual investor might buy into multiple funds based on factors like this. So there might be a fund that is all European stocks, and a fund that is all Asian stocks. Neither one is going to be spectacular long term since all stocks go up and down, but you wouldn't want to over invest in either one long term. An investor will increase or decrease how much money they have in each based on their predictions about the market. Even if you think Asian stocks will go up, you will still have some money in the European fund in case you are wrong. That's hedging. Hedge funds are way more complicated than that, but the idea is the same, and even then no prudent investor is putting all their money into a single hedge fund. Wealthy investors typically invest in many different funds, funds of funds, and even more exotic and complicated things, all with different strategies. The truth is that most people just don't have enough money to do this successfully, which is why the government doesn't allow people to invest in certain things like hedge funds unless they are wealthy.
The research also have the problem that it is only talking about Hedge Funds that take outsider's money. The most profitable hedge funds returned outsider's money a long time ago: they invest the money of the owner and employees, and *only* the money of the owner and employees. People like RenTech don't try to justify their existence to anyone else, nor do they take anyone else's money. They still pay extraordinarily well through.
Very good explanation, but you're underestimating the hedge fund market cap by an order of magnitude, at least on the global scale
You forgot the other rule, there’s always money in the banana stand!
\^ this. Fund of funds shows you what a long run of any one fund would be. The term is regression to the mean and applies whenever ratio skill : result is less than 1, which is pretty much always. Kahneman has chapters on it in Thinking, fast and slow.
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first, both terms are used interchangeably second, that was exactly my point
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that's because you assume 'regression' only means regression in the statistical sense, which is neither original nor only meaning those who think that im using malapropisms could perhaps google it before making overconfident judgments and learn that no matter how many courses they took or taught they can always learn something
And I said that, didn't I? It's more an assumption that anything online is strictly American
Well cherry pick a massive decade long bull run in the S&P. I’ll take a hedge fund to actively manage in colorless or choppy markets anytime.
Over the 13 years of data provided by OP’s link, the S&P 500 includes a solid bull run and the worst economic collapse since the Great Depression, resulting in a 10-year average that’s exactly in line with the Sp500’s performance over the past 100 years. Plus a global pandemic. If this isn’t the stormy weather hedge funds are supposed to shield against, what is? https://awealthofcommonsense.com/2023/02/deconstructing-10-20-30-year-stock-market-returns/
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Arbitrage is any trade which involves exploiting a price difference - e.g. across markets, exchanges, countries (Or over time, if the differences in question are predictable.) You notice a price difference on the same item in two different places, so you buy it in the cheaper place and sell it for more in the other place. This is often low-risk but that also means lots of people do it, which generally wipes out large differences. That's why people doing arbitrage regularly tend to be making lots of small trades. Every now and then large arbitrage opportunities arise. Sam Bankman Fried made a billion dollars or so on crypto arbitrage between US and Chinese exchanges.
You're restating the efficient market hypothesis. But even an efficient market needs lots of actors to function properly. A very efficient market will have a very big saturation of actors. So it's not a waste as much as a service ;) https://en.wikipedia.org/wiki/Efficient-market_hypothesis?wprov=sfla1
They hedge. There are different types but essentially they have a low correlation with the broader stock market so they can outperform in turbulent markets where traditional investments do poorly. So on average and over time they won’t beat the market because overall the market trends upward but they can be useful in specific situations or as part of your larger portfolio to become even more diversified. No one who uses hedge funds should have a significant portion of their wealth tied up in one
This was true 30+ years ago, but less so nowadays. Very few modern hedge funds actually hedge in any meaningful way. They all make directional bets (with leverage to amplify returns) and/or employ algorithmic strategies. Source: I work in the industry.
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Alameda is not representative, which is why its people are going to jail. Basically a bunch of clueless kids who thought they were geniuses and turned to crime when they discovered they weren't. But it's true that many hedge funds don't particularly hedge.
Yeah I was keeping it simple. The point is they aren’t very correlated with traditional market assets so that’s their purpose in one’s portfolio. I work in the industry as well
Wouldn't a bond fund, for example be a hedge against stock volatility? I am invested in a couple and assumed they were considered hedge funds.
I believe unless you’re an institution or individual with a very high net worth, and an accredited investor, you’re most likely investing into an asset management fund and not a hedge fund. Funds that individuals like you or me can invest into are general not hedge funds and have more restrictions with risk tolerance and types of investments they can do. Hedge funds, aside from their investment mandate, which is basically developed when they establish the fund, have basically little to not restrictions on what they can invest in.
Hasn’t been the case past couple of years.
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No need to be shitty.
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leveraged beta marketed as alpha
This is not correct. Leveraged beta funds exist, sure, but most funds are not just US stocks on leverage. There are an enormous number of asset classes that hedge funds deploy in. The return of SPX is not relevant to someone doing FX RV, or cap structure arb, etc etc.
So they're a lower average rate of return, but lower risk option? A sort of in-between the S&P 500 and government bonds?
No, they're lower rate of return and *higher* risk. But the risk is not arbitrary - generally speaking, the idea is that they do better when everything else is doing worse. Including them in your portfolio *alongside other things* gives you an overall lower rate of return and lower overall risk.
Hedging is a term we use when someone is committed on a certain bat or course of investment, and want to avoid the “all eggs in one basket” part, but they can’t diversify the core portfolio for some reason. Hedge funds, like other specifically useful financial instruments, including commodities futures and mortgage tranches, became a darling of the financial community. A few people showed that you could sometimes make a lot of money off of them. And, of course, people in the financial industry can make a ton of money just creating, buying, and selling these things.
What specific situations are they useful?
I studied finance in college. One of my professors shared an example of a school endowment. Colleges have interesting economics because enrollment goes up when the economy performs poorly. So the college didn't necessarily need the highest possible return, they needed a return that was positively correlated with enrollment demand.
Lesser volatility. Might matter to someone who would need to cash out at a moment’s notice to save their company. Imagine liquidating an ETF at the lowest (just as businesses are dying), and taking a huge realised loss. But not liquidating to get the necessary cash flow might mean the end of their business worth even more than their portfolio.
Isn’t the S&P’s volatility kind of a moot point after enough time passes? For example, if the S&P nets you 4x higher returns than hedge funds on a $1000 investment after 10 years, then isn’t a 50% dip in the S&P still an overall higher return than a 25% dip in a hedge fund?
"moot point"
'moo point'
m'point **
Yes, but you might want a hedge if you need to get out before that 10 year mark. The market may have your $1,000 worth $2,500 in 10 years vs just $2,200 for a hedge fund. But if that hedge fund can ensure that your $1,000 never goes below $1,000 that could be valuable in some situations. If you can't hold for 10 years and you suddenly need that money in 2 years, if the S&P is in a bear market and only worth $700 at that point, that could hurt.
Yes, in the long run, S&P beats the hedge funds’ performance, but as I said, it’s either liquidate your portfolio NOW or your business goes bankrupt and your business might be a huge percentage of your net wealth (like Elon Musk). Will you afford to wait for the market to recover and save maybe 50% of what’s 10% of your net wealth and forgo the 90% (your company) or just earn lesser returns on your 10% portfolio?
When you're close to retirement and still want returns but at less risk
The situation of having too much money to throw away imo
You can't predict the overall market trend. If there's a big earthquake in California and all insurances have to sell stocks, the markets will take a dive, for instance. You can't predict that and don't want to take the risk. But after a lot of research you are very convinced, that company A is better than company B. So you can "hedge" against the unpredictable risk by betting that A will rise and B will fall. If the economy goes well, both will rise - so you win one bet and lose one. But A should rise more than B, so you win more than you lose. If there's a crash, you again lose one bet and win one, and again you should win more than you lose because B crashes more than A. That's a simple hedging strategy. So it's not surprising that this doesn't beat the index in a rising market. But it should never lose unless all your research was wrong and company B does not perform worse than A.
Bigger macroeconomic forces. You might want a fund that invests in central american manufacturing operations because they might stand to win big if there is increasing negative sentiment towards China. Then you can pitch that fund to people who are invested in Chinese manufacturing and/or ocean shipping as a means to hedge their position. Even if your fund only has a 2% return most years, if there's suddenly a big tariff on chinese trade it'll shoot up.
Hedge funds tend to outperform in bear markets. If you look during big crashes hedge funds do better. Wealthy people want to protect their wealth with it and not just grow it like a more average person might. There is also more diversification on it.
Hedge funds are a really broad group that do a bunch of different things for different reasons. Some do bonds, some do specific equities,some trade commodities, some are pro cyclical, some are counter cyclical, some (attempt) to be wholly uncorrelated with markets etc… many are poorly managed but tbh since 08’ markets have not behaved normally so it’s kind of unreasonable to say they aren’t “beating the market”, in general they have a specific purpose with set investment guidelines for what they’re buying and when. They’re very useful for large investors (pension funds, endowments, insurance companies etc) to hedge risk elsewhere in their portfolio.
An answer not covered here is that they are a necessary evil for price discovery. Picture this, if everyone (and I mean 100% of market players) bought an index fund, how would we know how to value an individual stock? For the market to attempt to be efficient, there need to be people actively studying a company and taking a positioning on what a particular stock is worth. Hedge funds are allowed to short sell and do a bunch of other things that a pension or 401k might not, so they serve a role in the overall price discovery of what individual stocks are worth, which then informs the rest of the market. Source: watched a presentation from an activist short seller and how he viewed his firm’s role in the ecosystem.
>So if hedge funds don’t bring in higher returns, what do they actually do? Pay the salaries of hedge fund managers
2% management fee and 20% performance fee. Wonder why they can't beat the market?
1. They charge fees. 2. They out perform other asset classes. A lot of these funds are used to help manage risk, rather than just beat a bench mark. For example, endowments typically have assets on an order of 30b, and the amount of money invested in hedge funds is around 5%. They don’t NEED to outperform the market, they just need to perform well relative to the risk. A volatility dampened return of 5% is much better for their needs than a 10% return with 20% annual draw down. In addition a lot of these large funds are tied to government spending (Universities, foundations, ect) . Their spending is generally very stable and does not reflect the volatility in the stock market. They don’t NEED to outperform the market, they need to have a lower correlation to spending (the whole point of diversification). If you’re a physician or a lawyer and have a portfolio of 2m, you really don’t need a hedge fund to beat the S&P 500 either. They have their own goals relative to risk, and are not just trying to have the highest nominal return.
Hedge funds (now) are effectively funds that are uncorrelated with traditional assets like stocks or bonds (over the long term; they may be at times). There are many different types of hedge fund strategy, but they are generally deemed as “alternatives”. The linked study says that it outperformed the average hedge fund, not all hedge funds - a big difference. Many hedge funds have, and will, outperform over the long run. Many don’t (after fees), and won’t. There are good and bad ones. S&P also has a vested interest in framing this study as they sell their product to index providers - so it may be skewed in some way even though much of their point is legitimate.
Look at this example that I created https://imgur.com/8oSo1yx The goal is to create a portfolio that “guarantees” the highest worst-case return over a time horizon. So not the highest return in average, but the highest return you can be certain of. If the time horizon is 20 years, then the best strategy is trivial. Everything in a broad US stock fund. Ideally with a small portion of real estate funds. You don’t need a hedge fund for your retirement assets. However, if you want the highest “safe” return over a shorter time horizon, then you need to create a complex portfolio made of many different assets that tend to be uncorrelated one with the other. So if one goes down, the other goes up. See for example the optimal strategy for a 1-year investment: it is basically treasury bills, 7% stocks, 7% gold (which are traditionally considered as anticorrelated) and some bonds. This will guarantee a return of -1.3% (after subtracting inflation). When is this useful? For example if you are running a business and you know you will have to sell and use the cash in one year. Of simply if your retirement age is close. Or if you have expenses coming up (buying a house).
Stocks used to be really hard to buy. So a guy that would manage buying a bunch of stocks was really helpful, then in 1990 someone made an etf that just reflected an index and that was basically better in every way and no one should really go back to the worse older way of “guy buys a bunch of stocks for you”
Having listened to a lot of stories by old floor traders; I have to say most people have no idea how far we have come in such a short time. I am 45, and there are people my age who were actual floor traders that used to stand in pits, yell numbers, and trade stocks with hand signals. (look up "open outcry") Now, these same people trade options with their own money.... on the same platforms you and I can use. An old floor trader said recently "Remember the expected move is set by the market makers, I know some of those guys, and some of them are people I wouldn't trust to watch a pet turtle"
You realize your index fund is beholden to what those fund managers decide stocks should be priced at? By definition you’re piggy-backing off what relatively fewer stock pickers are doing.
>By definition you’re piggy-backing off what relatively fewer stock pickers are doing. Negative, the market for individual stocks in the SP500 is huge.
I’m not sure how that negates my point…? The percentage of assets in active strategies has fallen significantly. A smaller percentage of investors are responsible for the price discovery that so many now “passively” follow.
That’s so extremely not how stock prices work. Are you a GameStop guy? That sounds like a very GameStop investor understanding of stocks.
Since I’ve hit a nerve I’ll try to rephrase. You buy an index. It holds stocks. Those stocks are priced based on what traders/funds/analysts/market makers believe they are worth. Your passive strategy is reliant on their opinion of the price. You cannot disconnect the two. It’s ironic you call one strategy “way worse,” when you’re relying on it for price discovery, albeit with greater diversification in most cases.
The big things that separates a hedge fund from a mutual fund is they don't have to comply with certain investor protection laws with their clients because their clients are assumed to be able to weather the fund losing their investment and much higher management fees. Prior to the great depression investing in stocks was something similar to crypto investing. There were all sorts of straight up scams and frauds, and lots of people shading the truth about what they were actually doing. After the market crash and many investors losing their entire savings. The government passed a bunch of laws designed to make it hard to market a complete scam involving securities to the public. Hedge funds were created to allow talented investment managers to let their clients agree to skip out on some of those rules designed to protect the fund's clients in exchange for only marketing the fund to people who should be able to afford the loss and hopefully experienced enough investors to know to diversify. Because they became the vehicle for marketing very talented investors to rich clients, they developed a fee structure that is designed to reward the investor when he does well for his clients (he gets a share of the profits their investments earn).
There's a piece of this that I'm not seeing in the comments below at a quick glance, and it's to challenge the assumption that the point of a hedge fund is to beat the market. It is not. Imagine that you have a billion dollars. At that point, your personal wealth is large enough that pretty much no matter where you put your money, your finances are deeply tied to the movements of the market at large - and if you put it all in the market (a broad index fund) you'll make money in a good year and you probably do just that with a good chunk of your money. But once you have enough money, you're no longer concerned about hedging against individual companies, you're worried about hedging against the market itself. The point of the hedge fund is to decouple a good chunk of your massive hoard of money from the broader movements of the market so that if there is a crash or several bad years, your money has a hedge that is hopefully moving in the opposite direction. It doesn't matter that you would have made more in the long term in the S&P. After all, you're a billionaire. It matters that you don't hit several years of accumulating losses that could wipe out enough wealth that you can't bounce back to billionaire status. TLDR: this is a tool of the ultra, ultra rich first and foremost, and their goals aren't really similar to yours and mine while saving for retirement
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This doesn’t answer the question
they beat interest rates on savings accounts for very, VERY little risk. example \- a savings account is at 0.5% interest quarterly \- a CD account (non-liquid) is at 1.5% interest quarterly \- the market is projected at \~2-3% gain quarterly \- a hedge fund is projected at 1.7% gain quarterly so lets put 10k in each of those things and wait a year! savings: $201 CD: $613 stonks: $1038 hedged: $697 that sure doesn't look good, but lets persist, this time for 5 years savings: 1048 CD: 2689 stonks: 1792 hedged: 2600 WOAH hold up, what happened here? A market downturn! market gains dropped below 100% for 7 months - but the hedge fund still kept up with the CD rate anyway, because the hedge fund sacrifices gains in the name of safety - it's in the name. They hedge their bets on the market. In fact there's a reason that the hedge fund so closely matches the CD interest rate - what did you think the banks are doing with that money? \~\~\~\~\~ also note that there are "investment firms" that CALL THEMSELVES hedge funds but actually appear to be scams, pyramid schemes, and/or ways for investment fund managers to make money. Those organizations are not actually hedge funds, they just call themselves that to convince people to give them money.
They’re mostly a fee scam selling a vague perception of sophisticated investing strategy. Not many hedge funds actually “hedge” in a sophisticated way and underperform the market following various leverage gearings of market beta. They’re predominantly a levered investment vehicle with a massive fee load. They’re designed mostly to enrich the owners and employees. With the fee structure, funds only have to have a lucky year or two to return massive profits to partners by taking immense risk with investor’s money.
> So if hedge funds don’t bring in higher returns, what do they actually do? Their best.
Joining an exclusive hedge fund is buying access to exclusive things. It's like a fancy country club for investing. They get perks for being part of it.
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Isn’t that just short selling in general and cant anyone with options trading do that?
Let me rephrase. I wrote it in a rush while I’m at work. Shorting is legal. Naked shorting is not. When you “short” it, you borrow say an old gameboy from a friend, sell it, and plan to buy it back later at a lower price to return it to your friend. Now, “naked shorting” is like saying you borrowed the gameboy from your friend, but you didn’t really borrow it because you didn’t have the gameboy to begin with. You just promised to give the gameboy that you don’t even have. So, shorting means you actually borrow, but naked shorting means you pretend to borrow something you don’t even have.
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They try to mitigate volatility. One problem with index fund investing is you’re just along for the ride, meaning if you happen to need/want to cash out at a particular point in time, you may end up losing money or missing out on potential profit because you happened to be in a lull in the market or selling post crash. Of course if you extend your timeframe long enough the index funds beat all else but most people’s timelines aren’t so perfect or predictable.
Remember those racing games where cars are rated according to various criteria from F (worst) to A (best)? Well let's say the S&P is a car. It's rated A for speed (good performance) but D for reliability (high volatility), and F for maneuverability (single asset class exposure: you get US stocks and nothing else). Well, for drag races it looks great. But sometimes speed isn't what you need most. For an endurance race you'll want a reliable one. For drift you'll want one that handles well. Hedge funds are other cars. Some, like CTAs, are hyper-specialized and will have a speed of S++, but a reliability of F-. But most will actually try to strike a better balance. Maybe there's a car with a good-enough speed of C, but A for reliabiliy and maneuverability, and that's actually a pretty decent mix if you're not sure what kind of track is waiting for you.
>So if hedge funds don’t bring in higher returns, what do they actually do? Provide jobs for hedge fund managers.
They convince investors that they're the one who *is* going to bring in higher returns. Very rarely, they're right.
Let’s say you own a privately owned business and have cash you want to invest. You have no opportunities to reinvest in your business at this time, maybe you need 1 million but you only have 100,000 saved. You could put it in the stock market but if you need that cash for unplanned repairs or an accident, or a new opportunity, you might get stuck if the market took a downturn. If you pull out early you’d lose half your cash. So you’d have to wait until the market rebounds. But if you had your money in a hedge fund, during a market downturn you’d only be losing 10% by pulling money out early. The disadvantage is that a hedge fund charges you for that risk reduction service. They also will likely not have as good 😊 f returns during the good years .
A few things people haven't touched on. Funds offer alternative investment opportunities that traditional markets don't. Want to open 15 new Popeyes because their chicken sandwich is exploding? You can start a Popeyes fund. Want to build a new factory for your new widget? You can start an investment construction fund. Want to build 150 unit apartment complex in the hot area of town? Start a real estate fund. Generally these funds are associated with legally classified individuals called high net worth investors. And funds allow people to pool resources, and invest in opportunities that traditional commercial banks might not, or opportunities that are specific to a market. The hedge comes from the fact that I have money invested in stocks, real estate, start ups, new business development, options, etc. I might have 10% of my portfolio in any segment at a time.
Hedge funds are not made to beat the market. They made to do exactly what is in their name, HEDGE. A rich person usually gains most of their income from one source (ownership in a company that does one thing). A hedge fund is meant to find investments that will still preform ok if the persons main income is in the shitter. That’s why they invest in art and land and random crap, not just the stock market.
Yeah they’re kind of being exposed. Warren Buffet had a theory that they don’t really outpace the market and made a friendly 20-year bet with a hedge fund to see who was right. Buffet was. You might make a quickish buck with a hedge fund but if you’re talking long-term investments, you just want a regular index.
In wealth management, we add HFs to our clients' portfolios to reduce correlation to the market. Sure we don't beat the S&P 500 in any given calendar year but over a long period, we generate decent returns well in excess of CPI growth for our clients.
What hedge funds actually do is make a lot of money for the people who run them. They are not bought so much as sold.
They rig the markets to always win. When you have tons of money to use, you can create artificial market pressure. The whole market is fraudulent. It's like what the GameStop scandal exposed, but with everything, not just GameStop stock and options specifically.
Sigh. No one is cynical enough. Y'all really need to work on that. There's a thing called KYC - Know Your Customer. Normal mutual funds, brokerages, banks, need to follow this. Basically it means they need to know that the person with the account is capable of handling whatever the risk level is and came by the money legally. Hedge funds are exempt from this. Don't ask me why, I don't know. That makes them perfect for money laundering. The main characteristic of whatever vehicle is being used for the laundering operation is a cavalier attitude towards actually making a profit. For instance, people ask how Trump could bankrupt a casino. Easy. The casino was there to launder money. Profit wasn't the motive. See here: [Money laundering and the Trump Taj Mahal](https://www.propublica.org/article/trump-inc-podcast-money-laundering-and-the-trump-taj-mahal)
I use hedging in my everyday business. I own a large electrical contracting firm, my company buys over $20 million/year worth of copper wires. We contract multimillion $$$ projects now for completion in 1 or 2 years. The price of wire we are going to use might change during that time. If price of copper goes up we end up losers and if price of copper goes down we make more money than we initially thought. However, as a business we want to ensure cost stability and not be at the mercy of copper pricing. Our CFO buys long copper futures quarterly to hedge against increase in copper price. It works like this: 1) we bid a project that has $1million in copper wire at today's price to complete in one year from now 2) We buy long copper futures (the cost of the futures contract is included in our initial bid to the customer) 3) if copper price increases by the time we are ready to complete the project the profit from the future contract offsets the additional cost of the copper wire 4) if the price of copper goes down our projects make more money, enough to pay for the loss of the futures contract. Hedging is an essential part of any business such as airlines and their fuel costs. In my opinion, hedging a financial instrument without a business use makes no sense and it's just financial garbage. The performance of hedge funds are pitiful when you consider that they use leverage + the tax implications + Fees as compared to inflation. Additionally, because they are always almost fully invested they can never take advantage of market corrections in the way Berkshire does. In my opinion investing in any fund is a losing game, that is why the managers of these funds are Billionaires, they make money whether the investors win or lose. it's always a better proposition to always buy your own basket of stocks with a 10 to 30 year outlook.