Hedge Fund's money management...

[claudewang]

I think nowadays the annual return rate 20% for any hedge fund will be an excellent performance. But one thing always puzzled me is that if I give 100$ to a hedge fund, how much on average will they actually invest for me? For example if a hedge fund only risks 20% of their money, their trading strategies should give them 100% return rate (20$ profit from 20$ invested into the market) to obtain the 20% total profit for one year. If this is the truth, so can anyone insider simply give me a number (a feeling) that how much risk a normal hedge fund would take? Thanks for your answers.

PS: Andy...please don't tell me you also have to kill me this time...:-P

Claude.

 

[doug reich]

I believe many funds leverage their investments up at least 3-to-1, sometimes 5-to-1 or more. That means for your $100, they will invest $500. They do this because their strategies (and this is many quant funds I am talking about) return only a few % with low volatility that needs to be amplified to give the returns people expect.

 

[claudewang]

I believe many funds leverage their investments up at least 3-to-1, sometimes 5-to-1 or more. That means for your $100, they will invest $500. They do this because their strategies (and this is many quant funds I am talking about) return only a few % with low volatility that needs to be amplified to give the returns people expect.

Hi, Doug:

Thanks for your reply. I think the "leverage" you mean is the leverage of the financial product they invest. For example, the if they buy stocks without further borrowing money (margin lending), the leverage should be 1; if they buy index futures or options, normally the leverage is 10 or higher. But what I mean is how much money (how much out of the 100$ I paid to them) they invest into these leveraged financial products. As you said, I don't get it how can they invest 500$ when they only have 100$ given by me. It's unlikely they can borrow 400$ from somewhere else. I hope my question is thus clearer now.

Claude.

 

[Andy Nguyen]

You get x% return on your whole investment, not on the amount of money they use from your total investment. Also, the money from all investors is pooled so it's irrelevant how much of your money is used.
Your example of 100% return on $20 investment with $20 profit is not correct. The final number they report back to investors each year is more complicated than that.

 

[claudewang]

Andy, what you said is exactly what I understood. If they invest only 20$ out of 100$ and profit 20$, I know the return rate should be 20/100=20%, not 100%. And my example 100$ is just to simplify my question that we suppose the fund only have 100$ from all investors. So what I am curious about is what percentage roughly the fund would really invest into the market out of the money they acquired from the investors?

The reason I ask about this is because when I do back testing on my trading models, I can often have models with high return rate (>50%, invest 100$, profit > 50$). However those smart hedge fund's performances are very rarely higher than 20% that implies they must don't really invest 100% of investors money into money so that yields relatively lower profit rates. (For example, if the fund have a trading system with stable back testing 100% return out of the total invested money for the test, they will only get true 20% return rate when they only invest 20% of the whole investors' money for this fund.)

 

[triethanolamine]

Hedge funds do borrow money. Their leverage is not only in futures. The explosion in hedge funds in the last 10 years is largely due to trivial short term interest rates.

They invest all your money minus their pay-roll, rent, supercomputing fees, etc.