What Are Some Weird Hedge Fund Strategies
Mutual Funds Or Hedge Funds - Which Is Better?
There are few terms in the financial world that come across as mythical as “hedge funds”. What exactly is behind it and how do hedge funds differ from ordinary investment funds?
Hedge funds are criticized for being particularly aggressive and not even stopping at entire countries. Two hedge funds with Argentina have even sued an independent state to settle their claims.
That is why we have depicted the hedge funds in the picture above as a grasshopper - a stereotype that arose due to the sometimes very opportunistic approach of the hedge funds.
These and other breathtaking stories, which we cover in detail, have been instrumental in creating legends about hedge funds.
Mutual Funds vs. Hedge Funds: What's the Difference?
At first glance it is very surprising, but a hedge fund is essentially a “normal” investment fund. The astonishment quickly subsides when we look at other characteristics of the hedge funds.
A mutual fund is a capital collection point in which investors can invest their money. This money is then invested in the financial markets by the fund manager.
The fund manager uses his knowledge of the financial markets to generate a return on the investor's money. The amount of the return always depends on the risk that the fund manager is willing to take.
A mutual fund that specializes in stocks of small and largely unknown companies is relatively risky. In contrast, trading in the shares of established companies such as Daimler or Bayer is less risky.
The investment decision for a corresponding fund essentially depends on how much return you want to potentially generate and how willing you are to take risks.
The fund manager can not only trade stocks. Any other form of securities such as bonds or promissory notes is conceivable. There are also real values such as real estate.
Mutual Funds vs. Hedge Funds: Higher Returns from Short Selling?
The history of the first hedge fund goes back to 1949. Back then did Alfred W. Jones decided not to just buy strong stocks. He wanted too sell weak stocksin order to better compensate for fluctuations in its entire portfolio.
Jones was a versatile person. He studied sociology at Harvard, was an American diplomat in Germany and worked as a journalist during the Spanish Civil War.
His idea was to hand over the sold shares to the buyer at a later date. In the meantime between the sale and the handover - according to Jones' idea - the value of the shares sold should fall so that the shares could be purchased and delivered more cheaply shortly before the delivery date than they had previously been sold.
Such so-called “short sales” are common practice in the financial markets today. As I said, Jones wanted to secure his positions in this way. "Hedge“In its original form, it means securing your own positions.
In addition, Jones also wagered money he didn't have. So he took out a loan for it and tried to make a profit with it that exceeded the interest he had to pay on the loan.
Forbes Magazine published an article in 1966 that first used the term “Hedge funds“Has been used and has since established itself for a variety of strategies. We'll discuss different types of hedge fund strategies in more detail later.
Are hedge fund strategies more aggressive than mutual funds?
The industry has been heavily influenced by a few distinguished people. We'll take a closer look at a few of them and try to understand what connects them all.
George Soros - often had the right nose
When you think of hedge funds, it comes first George Soros comes to mind, a world renowned investor.
In 1992, Soros raised the equivalent of US $ 2 billion for its fund through currency speculation. He had an income of no less than $ 650 million that year.
LTCM - after the soaring came the fall
Hedge funds not only stand for very high profits, but also for major crises in the financial markets. This is what happened to the hedge fund, for example Long-Term Capital Management (LTCM)administered by two Nobel Prize winners.
LTCM had achieved annual returns of 35% between 1994 and 1996. In 1998, however, the fund lost over 90% of its value within a few months.
The so-called Russia crisis in 1998 caused panic on the financial markets. In addition, LTCM had concluded many deals with Russian banks, of all places, which were no longer able to act.
Since LTCM was particularly large and bankruptcy would have affected other financial market participants, the hedge fund had to be bailed out by its creditors with 3.5 billion US dollars.
In contrast to its own money, the hedge fund had used too much outside money in its business that it could no longer repay. At the end of 1999, LCTM was finally dissolved.
Florian Homm - the German star in the hedge fund universe
With Florian Homm Germany had its most colorful hedge fund figure. The manager was initially very successful, but then he was accused of criminal offenses such as falsifying financial statements and manipulating prices.
Homm ran into problems with the US Securities and Exchange Commission and also special forces of the drug police were after him because he is said to have done business with South American drug dealers.
His company Absolute Capital Management (ACM) then almost completely lost its previous value of almost three billion US dollars.
One of his creditors even put a bounty on him and he was shot on the street in South America. Eventually he was arrested in Italy and jailed.
However, he was released in the middle of last year because the maximum legal length of pre-trial detention had expired.
Hedge funds and Argentina - a neverending story
More recently, a dispute between Argentina and two hedge funds over $ 1.5 billion has caused quite a stir. The hedge funds had sued the state for payment of this sum in the United States.
After Argentina went bankrupt in 2001, the hedge funds bought the country's bonds - which had lost almost all of their value - at very low prices. Now they are pressing for the Argentine government to repay the bonds.
In turn, he claims that an agreement has already been reached with the other bond creditors. The hedge funds were even found to be right in a US court. The only question is to what extent the court will enforce its judgment against Argentina.
It will definitely be exciting. Recently, the responsible judge even attested Argentina that it had behaved illegally and disregarded the judge’s judgment. So the dispute goes to the next round.
Hedge fund development in times of financial crisis
After a very successful development of the hedge funds until 2007, a real crash followed in the course of the global financial crisis.
The bankruptcy of Lehman Brothers As a result, hedge funds lost a major lender, had to pay more for loans, and, more generally, tossed risky assets on the market, causing prices to fall.
Many investors then withdrew from hedge funds, which put them under further pressure to pay off the investors. In 2008 alone, around 1,500 (!) Hedge funds were closed.
Many of the hedge fund strategies were not prepared for the sharp decline in bank lending and the lower risk appetite during the height of the financial crisis.
Mutual funds vs. hedge funds: suitable for which investors?
Today the broad mass of hedge fund managers seem to have "grown up". As a rule, they take on fewer risks than in their previous history. This also has to do with the fact that the investor community has changed.
In the past, particularly wealthy individuals often invested in these somewhat exotic funds. Today, however, it is mainly insurance companies, pension funds, foundations or pension funds.
They look for stable returns in times of low interest rates to meet their own obligations. In addition, hedge funds have a reputation for still generating good returns or maintaining capital in weak market phases.
In German law (Section 283 of the Capital Investment Code), hedge funds are described as special investment funds that carry out short sales and / or leverage.
A “leverage business” is a paraphrase for the fact that one “leverages” one's own return, so to speak, with money borrowed from others. For this to happen, the income must also be higher than the interest. Otherwise the investor will make a loss.
Because of the special risks hidden behind these transactions, the sale of hedge funds to private investors is prohibited in Germany.
This prohibition can only be circumvented if you qualify as a so-called semi-professional investor and invest enough money.
However, it is strange that, for example, certificates with a risk of total failure can be sold by any bank advisor to private customers.
Well, in any case, investment funds are also open to private investors, so that they are definitely a valid alternative to equity investments. We have compiled the fundamental differences between funds and individual investments for you in this article:
Mutual Funds vs. Hedge Funds: Who Is More Profitable?
In 2014, the return, at an average of 3.3%, was far from the highs seen in previous decades. Of course, this also has to do with the low level of interest rates and the strong stock markets.
By contrast, mutual funds investing in stocks have benefited from the good stock market phase. From a global perspective, they were able to generate a profit of around 13% in 2014. Investment funds that trade bonds still achieved a return of between 4.8% and 9.9% last year.
Still, hedge funds currently manage record assets estimated at $ 2.8 trillion. That's funny: on the one hand a relatively modest return, on the other hand more investor money than ever before.
One or the other, on the other hand, has said goodbye to hedge funds, as the fees (1.5-2% of the assets under management are common and a profit sharing of 18%) for the performance shown are now considered too high.
But they still exist, the big winners among hedge fund managers. So should the hedge fund Pershing Square achieved a return of 40% in 2014.
However, smaller hedge funds in particular are finding it increasingly difficult to cope with the pressure on returns. In 2014, around 960 hedge funds had to cease business.
What are the hedge fund strategies?
The “hedge fund” industry today is characterized by the fact that there are major differences between the individual funds. So one can no longer speak of one type of “hedge fund”.
Some hedge funds actually tend to hedge the portfolio, but some also speculate with huge sums of money on certain events and “turn their flags around the wind”. You act without a pre-determined strategy. That can mean big gains, but it can also mean big losses.
Basically, hedge fund strategies can be divided into the following categories:
This type of hedge fund strategy includes trading stocks and financial instruments based on the value of those stocks. The shares can be bought and held consciously or the instrument of short selling can be used. Combinations are also possible.
Such hedge funds do not necessarily have to limit their activities to certain countries or markets. Just like stocks, bonds - such as government or corporate bonds - can also be traded.
The "market-neutral strategy" tries to trade stocks and bonds in such a way that the income is as independent of current market events as possible. However, this also means that the hedge fund has to carry out a large number of transactions in order to adapt to market developments.
Funds that have the greatest possible freedom in the use of investor money are referred to as “global macro”. Global interactions are analyzed and an attempt is made to exploit these for a positive performance of the hedge fund.
Another hedge fund strategy is called “managed futures”. In this type of fund, investor money is managed by a Commodity Trading Advisor (CTA), which analyzes the markets on the basis of computer models. As a rule, such complex financial instruments are traded and not “ordinary” stocks or bonds.
A hedge fund that trades on certain events is also known as an "event driven" fund. The fund takes advantage of corporate bankruptcies, restructurings and mergers in order to profit from them either with securities or other financial instruments.
The fund management tries, for example, to predict the time of such events and to benefit from the resulting changes in the value of securities and financial instruments.
For example, if two companies are negotiating a merger or takeover, the hedge fund uses the so-called "merger arbitrage" strategy. He buys the stocks and waits for the predicted merger to occur and fuel stock prices.
It is also quite possible that hedge funds are even actively involved in negotiations or restructuring within the framework of their strategy and expertise.
But there are also events in the financial markets that go beyond situations such as takeovers or restructuring. Such “special situations” are part of the hedge fund strategy of the same name, which is aimed at extraordinary events on the capital market.
Such events include share buyback programs and capital increases, which usually have a noticeable impact on the share price.
Relative value strategies
These hedge fund strategies rely on using valuation differences between different trading venues or between securities and financial instruments.
This so-called arbitrage is usually very low, so that this hedge fund strategy often uses a lot of leverage to increase profits (and thus also the risks).
For example, convertible bonds can be traded, which certify the right to conversion into shares of the company concerned. This is known as the "Convertible Arbitrage" strategy.
In this case, the hedge fund strategy uses valuation differences between the two securities shares and convertible bonds.
In addition to this type of trading, hedge fund strategies can also target fixed income securities such as bonds. Price differences can be found, for example, between bonds and derivatives on bonds.
When a company goes through certain developments, such as a change in rating, the value of the equity (e.g. the company's stock) often reacts differently than the debt. The latter is generally not so prone to fluctuations due to the contractually stipulated lending rates. Hedge funds use these differences with the strategy of "Capital Structure Arbitrage".
Hedge funds can also deal with different interest rates that vary on bonds with different maturities. This so-called yield curve can also be traded if one correctly assesses the change in interest rates.
So what's better: mutual funds or hedge funds?
The answer to this question depends heavily on what type of investor you are and how your previous portfolio is structured. Investments in hedge funds are generally not suitable for small private investors - mainly because of the variety of possible strategies and the associated inadequate risk awareness.
Large capital collection agencies such as insurance companies or pension funds, on the other hand, are forced to spread the risks within their portfolios across different investments. Investments in hedge funds may make sense here.
However, the large number of hedge funds and their managers can no longer be compared with those of the past few days, which also took very large risks for high return prospects.
Now, hedge funds have been trimmed back to "normal" levels and have to compete with other investments such as "normal" mutual funds in terms of the fees that investors have to pay and the returns they generate.
Because, especially in the current, permanent phase of low interest rates, nobody has any more money to give away, especially not for high fees and performance fees, which are at the expense of returns.
So it's not surprising that hedge funds have posted significantly lower average returns than equity mutual funds over the past year.
Investment funds are therefore much more interesting than hedge funds for private investors. We have compiled the advantages of this type of investment and information on government subsidies for fund savings plans for you in detail in this article:
And what do you think? In your opinion, which form of investment is better - mutual funds or hedge funds?
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