Hedge Funds Explained and How They Make Money

here's a chart showing how much the 10  highest-earning hedge fund managers made in 2020 yeah those figures are not millions but billions   to put into perspective tim cook the ceo of apple  arguably the most valuable company in the world   made 15 million in 2020 which is a tremendous  amount of money but when you compare it to   someone like israel englander well it just looks  miniscule honestly you can hardly even see it   hey everyone my name is kenji and in this video  i want to explain what a hedge fund is and why on   earth they make so much money in short a hedge  fund is essentially a structure that lets you   invest your own money as well as other people's  money into any kind of investment that you want   without really too much regulation so let's get  into the details there's really five main parts   that i want to cover the first one has to do with  the clients then we look at the fee structure the   investing strategies the risk levels and lastly  how the performance is actually measured so who   are the clients there's really two main sides to  this on the one hand we have we have the general   partner which is basically a person that actually  manages the money and typically tends to put a   portion of his own money in there as well and then  on the other side we have the limited partners   which are all the different clients that bring  in the majority of the money really for the fund   and typically limited partners might include  pension funds sovereign funds endowments as well   as some high net worth individuals and just to be  clear these funds don't actually accept money from   normal people like you and i and they have  sort of a minimum requirement so essentially   a minimum amount of money that you need to put in  it's typically well above the million dollar mark   and in addition to that they have a lock-up  period which essentially means that you can't take   the money out for a set number of period usually  something like five years so even if you need that   money they don't let you take it out that's why  it's mainly only open to sophisticated investors   so let's look at their fee structures  typically two types of fees in a hedge fund   the first one has to do with management fees  and these are typically a fixed percentage   on a yearly basis say around the two percent  mark so that's two percent of the assets under   management which is basically the amount of money  that the fund manages the second type of fees has   to do with performance fees which are typically  a percentage of the profits so these are not   guaranteed and they're not fixed so essentially  if the fund does well and has a positive return   they'll typically take a 20 of that so let's  look at an example suppose this hedge fund   manager manages a 100 million fund every year he  gets a management fee of two percent so that's   basically two million to pay for salaries etc  now the beauty of this here for him is that   regardless of whether he wins or loses money he  gets a guaranteed two million so essentially he   guarantees that he'll be able to pay everyone  and all of that stress is is gone essentially   as for the performance fee let's say he's up 30  million this year typically the performance fee   is around 20 so essentially he gets 6 million  for that that's basically the structure but now   imagine the fund is actually a 100 billion fund  hedge funds of this size actually do exist by the   way and now this management fee is not 2 million  but rather 20 billion and if his fund was up 30   that's 30 billion and for him that would be 6  billion in performance fees so you can really   start to see how they get so rich and how they  enter the forbes list for this for instance but   that said it's obviously not easy to raise funds  of this size let alone actually perform with them   so a common term they use in finance is called the  two plus 20 and by that they essentially mean this   two percent management fees and 20 of profits all  right let's look into their investment strategies   so because there's so many types of hedge  funds we'll just focus on three of the most   popular strategies and those are global macro  quantitative or quant as they might call it   and event driven so let's get into each a global  macro strategy bases its investment decisions on   global economic and political trends instead of  focusing on individual companies that basically   means that they take a top-down approach they  base their decisions on things like interest   rates economic models currencies or politics their  investment cycles typically medium to long term   where they might stay into something for even a  couple of years among the most famous global macro   hedge funds are bridgewater which is the largest  hedge fund in the world as well as more capital as for quantitative hedge funds essentially a  quant hedge fund doesn't rely on humans for their   trades instead they rely on algorithms that base  their investment decisions so essentially they   employ a big army of physicists mathematicians  and computer scientists to create an algorithm   that will predict the investment opportunities  and basically executes them automatically   their focus is meaning short term sometimes even  less than a second to enter and exit a trade   that's why they use computers for that and  nowadays quant hedge funds are probably the   most popular especially given they're really  good returns compared to some other hedge funds   and among the most famous ones are two sigma  and the show the show was actually founded by a   computer science professor at columbia university  so it kind of explains the type of people that   work there and lastly we have event driven hedge  funds which basically target missed pricings   because of major events like an acquisition  an earnings call or a bankruptcy say   so their research mainly involves really getting  into the financial statements of companies   reading all their public documents and  trying to get as much information as possible   an example of their strategy could be a healthcare  company waiting to see if a new game-changing drug   that they invented is going to get approved  by the regulators and depending on that that's   going to have a big impact on that company and so  they might the hedge fund would take a positive   or negative position depending on that and try  to predict it so these are typically short and   medium term investments and among the most famous  hedge funds are davidson kemper and dupont capital   so these investment strategies i mentioned  are typically quite generic and sometimes   they're a lot more narrow and specific like  say once one particular country or other times   they might use hybrid models where it's a bit  of quincy and a bit of global macro and they try   to merge that together let's now look at risk  and regulation see with a normal fund like say   a pension fund where you or i might put money  in they're actually very regulated essentially   they're not allowed to use certain financial  instruments for example they're not allowed to   incur that sometimes they're limited to specific  countries and various other things like that   essentially as a normal consumer you  don't want them to lose your money so   basically they're very risk-averse in that  sense and they're highly regulated as such   as for a hedge fund the risk levels are actually  very different it's a completely different story   mainly because they only deal with sophisticated  investors and they're not regulated at all and so   they basically can do anything they want as long  as they make money that's really all that matters   to them and to illustrate just how far they're  willing to go to make money check this article out   it was written by business insider back in 2012  and says that the hedge fund has physically taken   control of a ship belonging to argentina's  navy now if you look into the details it's   because argentina hasn't paid back a 2001 bond  that they owe to them that's actually 11 years   ago we're talking about since 2001 so yeah they  rocked up to ghana and seized the military ship   say for a pension fund well they probably won't be  allowed to go all the way to ghana to take a ship   and secondly they probably won't know what to do  with it i don't know what these guys did with it   but it's just to illustrate the extents to which  they're willing to go and they can't go because   of the regulation lastly there's performance  i'd say there's two main metrics for this   returns and diversification for returns we  typically measured against the benchmark   so for instance it might be measured against  the s&p 500 so anything above that is positive   anything below is negative it's that simple really  another big performance metric is diversification   so basically because what they do is so different  to your average investor that basically means   that they're not correlated to the market so  even though the market might be in a recession   the hedge funds might actually be doing well and  making money and that's something that's very   attractive to investors obviously the opposite  also applies when the market's doing well maybe   they're not doing so well and that's not good  but overall the investors like that mainly for   diversification really so yeah that's  the summary of hedge funds thank you   for watching i hope you found it useful  i'll leave two books in the description   if you're interested in some further reading  on a topic and i'll catch you in the next one

Channel: Kenji Explains

Views: 58,007

Keywords: hedge fund, hedge funds, mutual fund, pension fund, investing strategies, hedge fund manager, hedge fund billionaires, investment strategies, quant hedge fund, investment banking, hedge fund fees, how hedge funds make money, hedge funds explained, hedge fund investing, what is a hedge fund, quant, hedge fund strategies, hedge fund explained, how do hedge funds work, hedge fund manager salary, stock market, hedge fund trader, archegos, archegos capital, archegos explained

Id: BXXTh1Hn8lo

Length: 8min 38sec (518 seconds)

Published: Fri Apr 02 2021