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A thread on hedge funds, shorting stocks and trading vigilantes.
1. First, let’s cover hedge funds. A hedge fund is simply a fund that collects money from wealthy investors and institutions (universities, foundations, etc) that use different strategies to try to beat the market.
1. First, let’s cover hedge funds. A hedge fund is simply a fund that collects money from wealthy investors and institutions (universities, foundations, etc) that use different strategies to try to beat the market.
2. These funds tend to be extremely expensive, collecting as much as ‘2 and 20’ which translates into a 2% ongoing fee plus 20% of the profits. Most charge a little less and some charge even more.
3. Most hedge funds end up underperforming the market. This is where a bunch of people on FinTwit tell me that the point of hedge funds isn’t to beat the market. For many hedge funds, that is the point and they still largely underperform.
4. If they underperform why do rich people and institutions invest in them? The short answer is wealthy people and big institutional boards are no smarter than most other people. They fall for silly narratives and are just as greedy as everyone else.
5. The result? Most hedge fund investors pay more fees, pay more in taxes and underperform a much simpler strategy.
6. Most of us are familiar with buying a stock. This is referred to as being ‘long’. You want the price to go up. If you buy one share of McDonalds stock at $206 and it ends the day at $207, you make $1.
7. Some hedge funds and other traders ‘short’ stocks. This simply means the fund will make money if the stock goes down. If you short one share of McDonalds stock at $206 and it ends the day at $205, you make $1. If McDonalds ends the day at $207 you lose $1.
8. If you are long a stock, you can only lose your initial investment. If you buy one share of McDonalds at $206 and the company goes bankrupt, you lose 100% which is $206. Sucks when that happens by the way.
9. If you short a stock, your losses are unlimited because a stock can simply keep going up. If you bought McDonalds at $206 and it goes up to $824, well, you just lost 300%. This is because you lost the difference between $206 and $824. Now that REALLY sucks.
10. How do a few top hedge fund managers play (nice word for manipulate) this game? They find a stock they think is overpriced. They then short the stock.
11. They then announce they shorted the stock. They announce they shorted the stock in various ways.They sometimes do this at a charity event which somehow makes it worse. Some go on CNBC and ‘talk down’ (aka bash) the stock.
12. Others that own the stock, fearful they own a loser position, start to sell. The stock goes down, cost of borrowing goes up and sometimes the company goes bankrupt. The hedge fund closes out their position and walks away with the profits.
13. Trading platforms stay open for these traders, regulators leave them largely untouched and no one complains. Now we have some retail investors doing similar things (buying positions and talking them up openly and transparently) and somehow this is completely unacceptable.
14. Bottom line: most hedge funds underperform, are high fee and create lots of taxes. Most people shorting end up losing money. Most people day trading (for whatever reason) end up losing money.
15. It’s boring but buying quality companies and holding for long periods of time is the best path to prosperity and also that path the very wealthiest tend to follow. Also, hedge funds are largely bad investments (had to throw that in again).
