Those Nasty Hedge Funds
...three basic ideas among several more that every investor in a hedge fund should understand.
Many people have been asking me if there has been any fallout for my fund over the failure of Amaranth. Have my investors been calling me asking questions?
First of all Amaranth was not a hedge fund, they were a levered fund. What did they hedge?
Secondly, many of these hedge funds make serious structural mistakes that lead to problems with their investors.
They Promise Investors Rates of Returns
Opportunities do not come linearly in the markets so how can you promise your investors certain returns? If you do, you are trying to fit a square peg into a round hole and at some point will be forced to do stupid things to deliver those returns: increase risk through increased leverage. Because my fund does not promise our investors a certain return, we are under no pressure to deliver something that is not possible. We instead behave in the opposite manner and de-lever and reduce risk when we see little opportunity. Our investors do not expect any rate of return; they only expect us to control risk.
They Are Not Clear on How They Make Their Money
They have a basic strategy and often deviate into other things where they have less experience. My firm does one thing and one thing only, we trade volatility. This allows our investors to put us in their portfolio and feel comfortable that we will perform in a certain way given market conditions. We provide our investors with full transparency. They never need to fear we are hiding anything because they have access to our full portfolio at all times.
They Get Too Big
It is essential that a hedge fund never outgrow the liquidity of its markets. We have been careful to size our business commensurate with the liquidity of the markets in which we trade. We could liquidate our entire portfolio in a day with no market impact and because we provide full transparency, our investors are confident of this. A related thought is that when you get too big, by definition you have investors that are "hot" money that will leave you at the first hint of underperfomance. We have never lost an investor; we know them well.
These are three basic ideas among several more that every investor in a hedge fund should understand.
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