Hedge funds are often thought of as murky pools of capital, accessible only to the super wealthy. The only times the public hears anything about hedge funds are when they do something illegal or outrageously profitable. Generally speaking, these partnerships are much less secretive than you may think.
To demystify hedge funds and explore ways that an everyday investor can benefit from their strategies, Breakout welcomed Maz Jadallah, founder of AlphaClone.
What is a hedge fund?
Jadallah says hedge funds are "an investment fund that has a much wider range of investment activities than a mutual fund." Broadly speaking, hedge funds have a mandate of making money, no matter what the market is doing.
For instance, if the stock market is down big, such as it was in 2008, your vanilla mutual fund would be expected to fall with it. A hedge fund manager has no such excuse. Hedge funds typically get a management fee of around 2% per year and take a cut of the profits up to 20%. Whether or not these steep fees are worth it depends on the fund.
Among the strategies you're not going to see at your basic mutual fund are a dedication to the use of leverage, meaning the fund will borrow against their portfolios to increase the size of their bets. Using $300 to buy one $600 share of Apple (AAPL), for instance.
As Jadallah says, that kind of leverage can "accentuate gains but also accentuate losses."
Who can invest in a hedge fund?
"The SEC has restricted who can invest in hedge funds because of the 'sophisticated nature' of hedge funds," says Jadallah. In theory, these accredited investors will be able to understand the hedge fund. In reality it comes down to money.
To be a hedge fund investor, individuals need to qualify in one of the following ways:
- Be an individual who has made over $200,000 per year for two years.
- Be a married couple with over $300,00 a year in joint income.
- Have a net worth in excess of $1,000,000, not including their home.
What can individuals do to imitate the strategies of successful hedge funds?
Jadallah says investors who are looking to invest like a fund can do three things.
First, they need a time horizon of three years or more. Jumping from hedge fund to fund doesn't work for mutual funds, hedge funds, or stocks.
Second, individuals usually fail to protect their downside the way a hedge fund would. Automatic sell rules will keep you from riding losing positions down to zero. Jadallah uses a monthly close below a stock's 200-day moving average as a trigger to sell. Other techniques include a drop of 20% or sharp one-day moves.
Finally, folks at home can follow the managers themselves and study what they do. Any fund with more than $100 million of clinet money much file its positions with the SEC within 45 days of the end of a quarter. This includes equities, preferred equities, puts and calls. These filings give the regular public a glimpse into the what these high paid Wall St kings are doing from quarter to quarter.
These filings enable folks at home to see what good managers are doing.