Hedge Fund

Why do the bigwigs of hedge funds have personal fortunes that often reach into the tens or even hundreds of billions?

Today, let's talk about how they "harvest the leeks" (a colloquial term for making profits at the expense of retail investors).

(Note: "Harvesting leeks" is a metaphorical expression in Chinese financial circles referring to the practice of experienced investors profiting from less knowledgeable ones, often through complex trading strategies or market manipulation.)What is a Hedge Fund?

A hedge fund is one of the highest-risk products in an investment portfolio. It can be a fund where the fund manager invests as they see fit.

General funds, such as insurance funds like pension insurance, social insurance, and medical insurance, cannot be invested in randomly. The government usually has strict regulations for these funds, with certain requirements for their investments.

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Hedge funds are different; they can invest in whatever they want, so they have certain requirements for fund investors.

Generally, only very wealthy people invest in hedge funds, even if they lose money, it will not affect their normal life.

Due to the rapid changes in the entire financial market and financial products, hedge funds do not have a fixed classification.When it comes to investing, many people might think of buying stocks to some extent.

Warren Buffett does not operate a traditional hedge fund; he primarily engages in a type of value investing.

He identifies the fundamentals of a company that he is optimistic about, then conducts some analysis, and if he believes there is investment value, he will buy heavily.

For example, Coca-Cola and Geico Insurance are among his very successful investments.

Hedge funds also invest in stocks, and their pioneer is called... (The sentence is incomplete, so I cannot provide a complete translation for the last part.)Long/Short Equity Strategy

In 1949, the founder of the first hedge fund, A. W. Jones, when he was bullish on a stock A, he bought it to go long. If the stock went up, he made money; if it went down, he lost money.

At the same time, he wanted to hedge some of the risks associated with this stock, so he engaged in short selling. He shorted another stock B in the same industry. Now, if the stock went down, he made money; if it went up, he lost money.If he invests in the stock market when the industry is not thriving, and stock A incurs losses, then he can make profits on stock B, which can help recover part of the losses.

The actual operation is much more complex, and it also needs to consider the correlation between stocks, the correlation between stocks and some indices, as well as some leverage factors in between, and so on.

For stock selection, we need to look at the company's financial reports, the fundamentals, and market analysis.

Now there are more hedge funds that use machine learning algorithms for stock selection, which is fast in computation and less prone to errors.

Generally, we call these funds that use programming algorithms "quantitative funds" or "quant funds".

(Note: The original text was cut off at the end, so I completed the sentence based on the context.)Quantitative Funds

Quant Funds

In these funds, there are generally some very skilled individuals in programming and modeling, such as Ph.D. in Physics, Ph.D. in Mathematics. They strive to find an excess return over the market benchmark, known as Alpha.

Bridgewater Fund

Currently, the largest hedge fund in the world is called Bridgewater Fund (Bridgewater), managing assets of approximately 138 billion US dollars.Bridgewater Associates has a strategy that is also the name of one of its funds, called Pure Alpha.

They also have another very common investment strategy, which is mainly focused on macroeconomics:

Macro Strategy

Global Macro

Ray Dalio, the founder of Bridgewater Associates, initially engaged in macroeconomic research and invested in products related to the national macroeconomy, such as currencies, stock indices, government bonds, and so on, which differs from investing in individual stocks.Bridgewater Associates became globally renowned in 2008 for their accurate prediction of a massive bubble in the market economy, which was highly likely to crash, leading them to aggressively short sell.

The film "The Big Short" tells the story of profiting from short selling the economy and reaping huge benefits.

In 2008, while the global hedge funds suffered losses of over 500 billion USD, with an approximate drop of 30%, Bridgewater Associates made a profit of 10%, creating a 40% gap with their peers.

Currently, the total assets of Bridgewater Associates amount to a staggering 140 billion USD.During the pandemic, the U.S. stock market experienced multiple circuit breakers, and many investors suffered heavy losses. At that time, there were also reports that Bridgewater Associates had a blow-up.

Thus, we can see that hedge funds have high returns, of course, but also high risks.

The economy is cyclical, and I will introduce the relevant content of the economy in detail in subsequent articles.

Bridgewater Associates' macro strategy generally starts by making judgments on the economic cycle, and based on this judgment, they make corresponding investment strategies.

George SorosAnother approach is not just to profit from analyzing economic cycles, but to identify the inevitable decline after the peak of the cycle and deliver a heavy blow, leading to its complete collapse.

Its representative figure is George Soros.

They are best at launching an attack when you are about to fail, and then making a fortune when you are in dire straits.

For example, in the early 1990s, the British economy was in a slump, and the Bank of England kept buying to prevent the devaluation of the pound. At that time, Soros believed that the Bank of England would not last long and would soon run out of funds.Soros immediately prepared to short the British pound, gathered many big capital players, and continuously sold the pound, while the British government kept buying in an attempt to save it. In the end, of course, the rescue was not successful.

As soon as the pound fell, it was immediately collectively sold off, and ultimately, Soros and others successfully made a huge profit.

High-frequency trading

There is also a risk-free arbitrage model.

For example, the same commodity is sold for 1 yuan in City A and 2 yuan in City B. Then it is possible to purchase in City A and sell in City B, which is buying low and selling high, with no risk in between.This is akin to the high-frequency trading we often hear about, which relies on quickly and accurately identifying minor differences in stock/currency prices to ultimately extract profits.

It is interesting to note that most of their companies are located next to exchanges. So, is it really about proximity and faster algorithms? Everyone can chime in with their thoughts.

Another form of arbitrage is used in financial derivatives, where the pricing of derivatives is quite complex.

There are experts in the market who specialize in pricing models, and they will study the differences between theoretical prices and actual prices. If there is any mispricing, they will find ways to arbitrage from it.

Event-drivenThere is also another type, event-driven strategy.

For example, if Company A plans to acquire Company B, the stock price of Company B is likely to rise. Whether the acquisition will be successful or not is uncertain.

For example, whether a company will go bankrupt.

For example, whether a certain stock will be included in the stock index.

......

(Note: The original text seems to be cut off or incomplete, so the translation may not fully convey the intended meaning.)There will be hedge funds speculating on whether this matter can be successful. If they guess correctly, they make money; if they guess wrong, they lose money.

Why are hedge funds so profitable?

On one hand, it's because they have high leverage and high risk, so the potential earnings are naturally high as well.

On the other hand, the marginal cost for individuals is not very high. Hedge fund investors are very capable, and they have many investment strategies. With very few people managing large amounts of capital, the earnings they receive are naturally high.

Some people say that the existence of hedge funds is to undermine national funds and to exploit the small investors. However, their existence also identifies unreasonable economic prices, providing the market with more competition and liquidity.So, the market also needs the existence of hedge funds.