Hedge fund, in English, is Hedge Fund, which means "fund that hedges risks". It is also called "hedge fund" or "arbitrage fund". Typical characteristics of hedge fund transactions are: Transaction oriented, not investment oriented; Keen on increasing leverage and pursuing high profits, but it also comes with high risks; The goal is arbitrage, and two strategies, long and short, will be adopted. Currently, global hedge fund managers have approximately US$3.3 trillion in assets, and their main investors are financial institutions and high-net-worth individuals. Hedge funds are not something ordinary retail investors can invest in. They have high entry requirements and extremely high investment risks. Hedge funds have a long history, but their meaning has fundamentally changed in different eras. Although not many people can participate in hedge fund investments, hedge funds are involved in almost all areas of financial investment. Hedge funds first originated in the United States in the early 1950s. The main purpose of their operation is to use financial derivatives such as futures and options, as well as short-selling and short-selling operations on different related stocks, to avoid and resolve investment risks to a certain extent. Simply put, it refers to a fund that uses gains to offset losses. In the 1980s, with the rapid development of financial liberalization and the increasingly mature and diversified financial instruments, the role of hedge funds has undergone major changes: Hedge funds have gradually changed from their original purpose of “offsetting losses” to “earning greater profits”; The timing of hedge fund operations has also changed from being carried out after other investment operations, using its own profits to hedge the risk of investment losses, to now being carried out independently and proactively, relying on the hedge fund itself to earn profits; It can be said that today's "hedge funds" are no longer the "hedge funds" of the past. They just use the past names, and the investment purposes and methods have undergone great changes. The current understanding of "hedge funds" in the financial world is that fund managers make full use of various financial derivatives such as futures, options, interest rate swaps, and foreign exchange swaps to make speculative investments. They pursue high risks and high returns as an investment fund, and usually bear greater risks than the overall market. What are the characteristics of hedge funds? Current hedge funds have the following characteristics: 1. Fund type A hedge fund is a private fund run independently by a fund manager (Hedge Fund Manager) who determines the financial products to invest in. 2. Supervision intensity Hedge funds are not as strictly regulated as mutual funds (Mutual Funds). Hedge funds generally have more leeway to pursue investments and strategies that may increase investment returns or risk. 3. Participants Hedge funds are only allowed to take money from so-called "accredited investors," such as individuals who have earned more than $200,000 a year in the past two years or have a net worth of more than $1 million, excluding their primary residence. 4. Investment objects Hedge funds can invest in almost all financial products, including land, real estate, stocks, various financial derivatives, and currencies, and can do both long and short positions. Mutual funds, on the other hand, are usually long-only. 5. Investment methods Hedge fund investments are almost always leveraged, often using borrowed funds to amplify investment returns and are allowed to make aggressive short investments. This approach may earn high returns, but it may also lead to heavy losses and bankruptcy. 6. Investment costs The high risks of hedge funds require fund managers to have great market judgment capabilities. As a result, the fund manager's return will be much higher than the income of ordinary fund managers. Hedge funds usually adopt a fee structure of 2-20: 2%: During the investment process, regardless of whether the investment fails or succeeds, the hedge fund manager will charge an asset management fee of 2%; 20%: If the investment is successful, 20% of the client’s income will be withdrawn as a fee; How do hedge funds work? Taking stock investment as an example, let's take a look at how hedge funds operate in the early and late stages. Early days In the initial hedging operation, after the fund manager purchases a stock, he also purchases a certain price and time-effective put option on the stock.
When the market value of a stock rises, the rising profits will offset the expense of purchasing put options. Similarly, when a stock falls, investors can sell the stock they hold at the price specified by the option, thereby hedging the risk of the stock falling in price. It can be seen that early hedge funds did play a "hedging" role and were used by conservative investment strategists to avoid risks and preserve value. Today When people realized that hedging could still make money in a bear market, its nature began to change. Hedge fund managers began to make high-risk investments with an aggressive attitude through a combination of multiple investment models. For example, from 1999 to 2002, general public funds lost an average of 11.7% per year, while hedge funds made 11.2% per year during the same period. For another example, during the subprime mortgage crisis in 2008, Bridgewater Hedge Fund’s Pure Alpha Fund actually achieved a profit of 9.5%. Sometimes, hedge funds will make already fragile stocks or financial markets even more vulnerable through "short selling" operations. For example, in 1991, "financial tycoon" Soros used the Quantum Fund to attack (short) the British pound, which severely damaged the British economy and forced the British pound to withdraw from the European exchange rate system. Soros, on the other hand, made a profit of US$1 billion through hedge funds. The most well-known investment methods of hedge funds are: short and long. What's going on with hedge fund short selling? Short selling, short selling in English, is the biggest difference between hedge funds and other funds. This also allows hedge funds to make profits in a bear market, or destroy a certain stock in a more aggressive way and make profits. For example, the Gamestop incident in February 2021 was originally due to two hedge funds, Melvin Capital and Light Street Capital, shorting GameStop stock, and was jointly bought by Reddit WallstreetBet. The operation method of short selling is as follows: If a hedge fund believes a stock will fall, it will first borrow the stock through futures trading and promise to return it at some time in the future. After borrowing the stocks, the hedge fund sells them in large quantities, which causes the stock price to fall rapidly; due to the huge number of stocks sold, it often causes a chain market reaction. If more retail investors and institutions follow suit, it will cause the stock price to fall further. When the stock price drops to a certain level, the hedge fund buys back the stock at a low price and returns it to the institution. Therefore, during the short selling process, if the stock price falls, the hedge fund can earn the difference in the price of the stock falling. The risk of short selling is that when a hedge fund sells a large number of stocks, a large number of investors in the market quickly take over, causing the stock price to rise instead of falling. At this time, the hedge fund had to buy back the stock at a high price and return the stock to the institution, and itself lost the difference in the rising stock price. The WallstreetBet vs. Melvin Capital incident is a typical case of short-selling failure, and it was a group of passionate retail investors who attacked hedge funds, which can be called a historic operation. What's going on with hedge funds going long? Compared with short selling, long investment is a relatively normal investment strategy, which is to buy low and sell high. When hedge funds believe that a certain stock will rise sharply in the future, they buy a large amount of it at a low price, raising the stock price. The rising stock price will attract more capital injections, and the stock price will continue to rise. When the stock price reaches the price expected by the hedge fund, the hedge fund sells a large number of stocks and earns a high price difference. The risk of going long is that the stock price does not rise or even falls. For hedge funds that hold a large number of shares, the losses will be much heavier than ordinary shareholders. How do hedge funds make money? How do hedge funds make money? As an investment, hedge funds invest in many financial products to obtain high profits from the price difference. For hedge fund managers, their profits are also considerable, and the current charging method is 2-20. 2 stands for 2%: This is a fixed fee for asset management. Regardless of the investment results, investors must pay 2% of the assets under management;
20 represents 20% of the income commission fee: when investors receive income, the fund manager can obtain a high proportion of 20% from the income as commission fee; Although this ratio seems to be too high for ordinary investors, for high-capital investors, the profits they may obtain are also considerable. What are the hedge funds in the United States? Currently, well-known hedge funds in the United States include: Bridgewater Associates, Renaissance Technologies, etc.: 1. Bridgewater Associates Bridgewater Associates is the legendary "Bridgewater Fund." Connecticut-based Bridgewater Associates remains by far the largest fund in the world in terms of assets. Founded in 1975 by Ray Dalio. As of February 2020, its assets under management reached US$160 billion. Some of Bridgewater's clients include institutional investors, philanthropic foundations, university endowments, and pension funds. According to Forbes, Ray Dalio received a salary of more than $2 billion in 2019 alone. 2. Renaissance Technologies James Simons, co-founder of Renaissance Technologies, also earned $1.5 billion in 2019. Renaissance is one of the oldest and most popular hedge fund firms, employing investment strategies that have produced high returns and with approximately $68 billion in assets under management. It provides services to corporations, trusts, individual investors, and financial institutions. Renaissance is currently run by Peter Brown, while James Simons remains a board member. 3. Quantum Group of Funds Quantum Group of Funds is the largest hedge fund managed by Soros Funds, the American "financial tycoon" Soros, and one of the largest hedge funds in the world. It was founded in 1970 by Soros and Jim Rogers. The fund has profited from multiple attempts to attack the currencies of multiple countries through financial instruments, most notably an attack on the British pound in 1992, an event known as "Black Wednesday." During the Asian financial crisis in 1997, Soros used short selling to attack the currencies of Thailand, Malaysia and other countries, and then prepared to attack the Hong Kong dollar. However, due to the strict defense of the Hong Kong government at the time and the strong financial injection from mainland China, Soros finally gave up his attack. However, this also caused heavy losses to Hong Kong's economy. At that time, Hong Kong's Hang Seng Index plummeted more than 3,000 points in one trading day. 4. Millennium Management Millennium Management Hedge Fund was established in New York in 1989 by Israel Englander with initial capital of US$35 million. It currently manages approximately US$48.3 billion in assets, with business covering the United States, Europe, and Asia. Israel Englander also earned $750 million in 2019. 5. Elliott Management Elliott Management is one of the largest activist funds in the world. It is headquartered in New York and founded by Paul Singer in 1977. The company not only invests in hedge funds, but also provides private equity and other services. Its current total assets are approximately US$42 billion. 6. BlackRock It was jointly established in New York in 1988 by Larry Fink, Robert S. Kapito and others. It was originally a risk management and fixed income institutional asset management company and currently manages approximately US$8.67 trillion in assets.
7. Two Sigma Investments Founded in New York in 2001, it was co-founded by John Overdeck, David Siegel and Mark Pickard. Siegel has a PhD in computer science. Overdeck is an International Mathematical Olympiad silver medalist. Two Sigma they established uses a variety of modern high-tech technologies including artificial intelligence and machine learning. Currently, assets under management are approximately US$58 billion. 8. Citadel LLC Citadel LLC, founded in New York in 1990 by Kenneth Griffin, is the world's largest alternative asset management firm, with current assets of approximately $35 billion. In February 2021, after Melvin Capital failed to short GameStop and lost 53% of its assets, Catadel and Point72 Asset Management jointly injected $2.75 Billion into Melvin. 9. D.E. Shaw & Co. Founded by David E. Shaw in New York in 1988, it is known for developing complex mathematical models and complex computer programs to earn profits from market anomalies. It currently manages approximately US$50 billion in assets. 10. AQR Capital Management Co-founded by Cliff Asness, David Kabiller and John Liew in 1998 in Greenwich, Connecticut, it uses a "systematic and consistent approach" to determine investment portfolio strategies and adheres to the diversification of assets within the portfolio. Currently, assets under management are approximately US$143 billion. 11. Davidson Kempner Capital Management Founded in 1983 by Marvin H. Davidson, originally named MH Davidson & Co., Thomas L. Kempner, Jr. In 1984 the company was renamed Davidson Kempner Capital Management and was later managed by Anthony A. Yoseloff. Currently, assets under management are approximately US$34 billion. Are hedge funds risky? Today's hedge funds are no longer the hedge funds that were created to hedge investment risks. The multi-field, more radical investment model once frightened those who were shorted by hedge funds in the market. But in fact, while hedge funds have such high benefits, they also face the same level of high risks. The main investment risks are as follows: 1. Less supervision They receive less regulation from the federal Securities and Exchange Commission (SEC) than other funds. Legally speaking, hedge funds are usually established as private investment limited partnerships, so investment operations controlled solely by fund managers cannot receive adequate supervision and protection. 2. More concentrated profits and losses Hedge funds are mainly controlled by hedge fund managers. Once the investment strategy fails, it will cause large and concentrated losses. And this process cannot be regulated and protected like ordinary funds. For example, Melvin Capital shorted GameStop, resulting in a loss of 53% of its assets, but the losses were heavy. 3. Lower liquidity Investments placed in hedge funds lack effective liquidity because hedge funds typically require investors to retain their funds for at least one year, a period known as a lock-up period. Later, some fund managers may require funds to be locked up for a longer period of time. Withdrawals of investment funds may only occur at specific intervals, such as quarterly or biennially. This means that once investment risks are expected, investors cannot withdraw funds in time and change investment strategies on their own. 4. Higher risk ratio Hedge funds usually adopt a leveraged investment model, which increases investment risks in proportion. Do hedge funds harm the economy?
The high risks of hedge funds themselves may lead to sudden changes in a certain industry, and in the interconnected economic environment, sudden changes in one link will often lead to a series of chain effects. Rather, as we mentioned before, Soros's shorting of the pound ultimately caused heavy damage to the British economy; Melvin Capital's shorting of GameStop almost caused GameStop to completely withdraw from the stage of history. What's going on with WallstreetBet vs Hedge Funds? The Wallstreet Bet vs Hedge Fund incident in February 2021 caused a sensation. It can be said to be a hearty gaming battle between retail investors and Wall Street hedge funds. The cause of the incident was that hedge funds were bearish on Gamestop’s stock. Gamestop is a long-established physical game store that is a fond memory for many American teenagers. Gamestop, whose performance was originally hit by virtual online games, was hit hard in 2020 when the epidemic was raging. This caused hedge funds on Wall Street to start shorting GameStop in an attempt to further put pressure on GameStop's valuation. But at this time, some investors, such as “Big Shots” legend Michael Burry, were long GameStop. Therefore, for a period of time, GameStop stock was in a stage of competition between long and short positions, but short positions had a greater advantage. Finally, the uncles of the Reddit forum have given up. The teenagers back then and the uncles now see that Gamestop, which is like their childhood playmate, is about to be completely defeated by hedge funds, and a "childhood war" is about to break out. On the Wallstreet Bet forum, which is dedicated to complaining about Wall Street, he shouted a declaration of war and gathered a large number of retail investors. He was once a "leek" but deposited money and became a "fighter". Retail investors bought as many GameStop shares as hedge funds sold, and even continued to inject capital, adopting an "ALL IN" approach. As a result, at the beginning of 2021 when the stock market was sluggish, Gamestop's stock price rose at an almost vertical angle like a mountain climb, catching hedge funds such as Melvin Capital by surprise. Although the situation eventually subsided, the hedge fund suffered heavy losses. For example, Melvin Capital lost 53% of its assets, which also made people realize the high risk of hedge funds. FAQ