The Premise

LabyrintheSo, I decided to take the plunge into blogging. I have no agenda outside of forcing myself to follow through with an investment strategy and learning something about blogging in the process.

The Hedge Fund Wannabe does not profess to have any superior knowledge about personal finance or investment strategies than anyone else. In fact, as you probably guessed from the title, I am a Wannabe. I have no connections to the finance industry, banking or commerce, nor have I ever worked in any of these fields. So, you are reading the musings of wannabe (a person who wishes to be or do something, but lacks the qualifications, experience or talent).

I do have some thoughts on the current state of the finance industry and maybe I was fortunate to have missed my calling. The entire premise of a hedge fund has been lost on a large portion of professional investors and wealthy individuals. They all seem to be chasing something, willing to pay high fees for what they think they cannot obtain without the guidance of professional money managers. In their haste, the premise is lost, and everyone is seeking Alpha (the value a portfolio manager adds above and beyond their benchmark). So what is the premise?

Well, lets look at the word: hedge. A hedge is an investment to reduce the risk of adverse price movements in an asset. So, really, hedge funds should be about risk reduction, but they have evolved to promise Alpha over the index for a fee.  They meet this goal about 30% of the time, but that’s not the point. The premise is lost. A hedge fund should not promise Alpha. It should limit downside risk in falling markets. The irony is that by promising Alpha (especially on a large scale as even small hedge funds now are measured in the hundreds of millions), the funds are actually taking on greater risk than their benchmark which means in declining markets they on average would fall more than their benchmark.

So where does this leave us? I would like to go back to the actual intention of the hedge fund. The idea of limiting downside risk. It’s great for investment professionals to tell all of us to index in the S&P 500 and to dollar cost average into them every paycheck. The reality is that it takes discipline but beyond discipline it takes a large amount of control over natural human emotions of fear and greed. When the market is going up, it is easy to keep putting a large portion of your post tax income away into S&P 500. However, when the market starts to drop ten, twenty, thirty percent or more, it takes a person who has reached a level of nirvana (the extinction of the three fires: passion, aversion, and ignorance) that most of us have not obtained to stay calm and not panic. Typically, the natural emotion of fear will cause a large number of both retail and professional investors to move to cash at precisely the wrong time.

I will get a lot more detailed in my next post, but my basic investment strategy is to go back to the roots of a hedge fund and limit my downside risk. That way when the market does fall, I will be able to sleep at night, and although I personally have not achieved nirvana, I will be able to continue to follow through with my investment goals. A caveat that some readers who have read this far may have already figured out is that by limiting downside risk I should expect my returns to be lower than my benchmark, but that my friends is what all hedge funds should strive to achieve.

2 thoughts on “The Premise”

  1. Very interesting perspective. I will be curious to see how the risk and return compare to a conservative mutual fund.

    1. Actually, I think some conservative mutual funds with low fees can be a fine investment vehicles. I will mention one in the following post that I think could potentially serve as a benchmark and has done quite well over the past 10 years. With actively managed mutual funds two important aspects come into play. One is the management and their philosophy and stability, and the second is the fees associated with said management.

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