Welcome back to the Net Worth Podcast.
Speaker 2: This week we are diving into understanding hedge funds and, maybe most importantly, how they can impact your net worth.
Speaker 1: We’ve drawn insights from a really fantastic piece, Hedge Funds Demystified, a Beginner’s Approach to Alternative Strategies, published in this edition of Noyack Wealth Weekly.
Speaker 2: You can check out the full edition on our website, wearenoyack.com.
Speaker 1: OK, let’s cut through some of the mystique here.
Speaker 2: Hedge funds, they sound pretty intimidating, don’t they?
Speaker 1: Like something only Wall Street insiders deal with.
Speaker 2: What exactly are we talking about when we say hedge fund?
Speaker 1: How are they really different from, say, a regular mutual fund?
Speaker 2: Yeah, they definitely have that aura.
Speaker 1: But what’s great about this addition is how it helps demystify them a bit.
Speaker 2: At their core, hedge funds are private investment vehicles, their main goal, usually aiming for above average returns, sometimes called absolute returns.
Speaker 1: by using pretty advanced strategies, the short selling, leverage, derivatives, stuff like that.
Speaker 2: OK, advanced strategies.
Speaker 1: Yeah.
Speaker 2: Right.
Speaker 1: And unlike the mutual funds most people know, they operate with fewer regulations.
Speaker 2: That gives the managers a ton of flexibility.
Speaker 1: But, and this is really key for your net worth, that flexibility, also means higher risks usually.
Speaker 2: It’s a trade off.
Speaker 1: So flexibility, higher risk.
Speaker 2: For someone just trying to get a handle on this, what does that mean in practice?
Speaker 1: Well, think of the hedge fund manager like a a highly specialized coach for an elite sports team, they’re not just picking stocks.
Speaker 2: They’re crafting really intricate strategies, constantly analyzing opportunities, making quick decisions across all sorts of assets.
Speaker 1: We’re talking stocks, bonds, commodities, currencies, sometimes even private equity deals.
Speaker 2: they’re playing on a much wider field, basically.
Speaker 1: Exactly.
Speaker 2: A much wider and often more complex field.
Speaker 1: Now, this edition also gets into how they actually work.
Speaker 2: Things like liquidity and fees.
Speaker 1: This sounds like it hits the net worth calculation pretty directly, right?
Speaker 2: How much cash you can get out and how much you actually keep.
Speaker 1: Oh, absolutely directly.
Speaker 2: The fund manager’s role is obviously crucial, developing strategies, doing deep research, balancing risk.
Speaker 1: But for your bottom line, your net worth, two things really stand out, liquidity and fees.
Speaker 2: OK, let’s start with liquidity.
Speaker 1: What’s the deal there?
Speaker 2: So liquidity.
Speaker 1: With hedge funds, you often run into what they call lockup periods.
Speaker 2: This means your money, your capital might be inaccessible for, one to three years, sometimes even longer.
Speaker 1: One to three years, wow.
Speaker 2: Yeah, it’s a significant commitment.
Speaker 1: And even after that lockup period ends, you can usually only withdraw money during specific redemption windows, maybe quarterly, maybe twice a year.
Speaker 2: So it’s not like calling your broker and getting cash the next day.
Speaker 1: Not at all.
Speaker 2: It means that capital isn’t readily available if you suddenly need it or if another great investment pops up.
Speaker 1: That’s a big planning consideration.
Speaker 2: OK, that’s a hurdle.
Speaker 1: And then the fees, I’ve heard about 2 and 20.
Speaker 2: That sounds like a lot.
Speaker 1: Right.
Speaker 2: How does that actually affect your wealth building over time?
Speaker 1: Ah, yes, the fees.
Speaker 2: This is probably one of the most talked about aspects.
Speaker 1: And for good reason, when you’re thinking about net worth, the traditional model was 2 and 20.
Speaker 2: That’s a 2 % annual management fee just for managing money based on your assets in the fund.
Speaker 1: Plus, and this is the big one, 20 % of any profits the fund makes.
Speaker 2: 20%.
Speaker 1: Yeah, it’s substantial.
Speaker 2: Now, this addition does note that things have maybe shifted a bit.
Speaker 1: It’s often closer to 1.5 % and 17 % these days due to market pressure and competition.
Speaker 2: Still pretty high, though.
Speaker 1: Still high, definitely.
Speaker 2: But there’s an important protection, usually, the high watermark.
Speaker 1: This means the manager only takes that performance fee, the 17 or 20%, on new profits that exceed the fund’s previous highest value.
Speaker 2: Ah, okay, so if they lose money, they have to make it back before they take a cut of the gains again.
Speaker 1: Exactly.
Speaker 2: It aligns their interest with generating consistent positive returns.
Speaker 1: But even so, these fees, year after year, can really erode your gains.
Speaker 2: They slow down the power of compounding.
Speaker 1: You might see a great headline return number, but what you actually pocket, your net growth, can be significantly lower.
Speaker 2: It’s crucial to understand that net of fees reality.
Speaker 1: Okay, so…
Speaker 2: Structure, costs.
Speaker 1: m What about the actual investing?
Speaker 2: What are these coaches doing?
Speaker 1: What kind of strategies does this edition mention?
Speaker 2: Right, the actual playbook.
Speaker 1: This edition highlights a few key ones.
Speaker 2: For example, uh equity long short.
Speaker 1: This is a really common one.
Speaker 2: Managers buy stocks they think will go up.
Speaker 1: That’s the long part.
Speaker 2: But they also sell short stocks they expect to fall.
Speaker 1: Selling short, betting against a stock.
Speaker 2: Precisely.
Speaker 1: It allows them to potentially profit whether the market’s rising or falling.
Speaker 2: Sometimes they even try to be market neutral, meaning their performance isn’t tied just to the overall market direction.
Speaker 1: Interesting.
Speaker 2: What else?
Speaker 1: Then there’s event-driven strategies.
Speaker 2: This is pretty fascinating.
Speaker 1: They focus on specific corporate events.
Speaker 2: Think mergers, acquisitions, bankruptcies, spinoffs.
Speaker 1: They do deep research into these situations and try to predict the outcome and how the market will react.
Speaker 2: Will the merger go through?
Speaker 1: At what price?
Speaker 2: They place bets based on that analysis.
Speaker 1: Very specific situations, not just broad market calls.
Speaker 2: Exactly.
Speaker 1: Very targeted.
Speaker 2: Then you have global macro.
Speaker 1: These managers look at the big picture, large economic trends, interest rate changes, politics, currencies across the globe.
Speaker 2: They might bet on the direction of the euro or predict a recession in one country versus growth in another and trade across different assets based on that view.
Speaker 1: Making big bets on the world economy, essentially.
Speaker 2: In a way, yes.
Speaker 1: And finally, there are quantitative or quant strategies.
Speaker 2: These rely heavily on computer algorithms and mathematical models.
Speaker 1: They analyze massive amounts of data to find patterns and opportunities, often executing trades extremely quickly.
Speaker 2: Less human intuition, more systematic processing.
Speaker 1: Wow, quite a range.
Speaker 2: And all these sophisticated approaches, they’re aimed at generating alpha, right?
Speaker 1: Returns above the market.
Speaker 2: That’s the goal, alpha.
Speaker 1: Returns driven by skill and strategy, not just by riding the market wave.
Speaker 2: OK, this all makes sense, but it leads to the really big question, doesn’t it?
Speaker 1: Yeah.
Speaker 2: Are hedge funds actually right for our listeners, for someone trying to build their net worth?
Speaker 1: That’s the crucial question.
Speaker 2: And the answer, as this edition makes quite clear, is that hedge funds are definitely not for everyone.
Speaker 1: The first big hurdle is the high entry barrier.
Speaker 2: We’re talking minimum investments, often starting at a million dollars, sometimes much more.
Speaker 1: A million dollars.
Speaker 2: OK, so that rules out most people just starting to build wealth.
Speaker 1: Exactly.
Speaker 2: They’re generally aimed at what regulators call accredited investors, people or institutions with significant income or existing net worth.
Speaker 1: So realistically, hedge funds are more about preserving and growing an already substantial net worth.
Speaker 2: If you’ve already got, say, over five million dollars in investable assets, then maybe they become part of the conversation to add another layer.
Speaker 1: And what about the risks we talked about?
Speaker 2: How do they factor in for someone who isn’t already wealthy?
Speaker 1: Well, the complexity and the risk magnification are major factors.
Speaker 2: Strategies like leverage, using borrowed money.
Speaker 1: Yes, it can boost returns, but it equally boosts potential losses.
Speaker 2: A bad bet in a leveraged hedge fund can hit your net worth much harder than a downturn in a standard mutual fund.
Speaker 1: Right.
Speaker 2: The downside is bigger.
Speaker 1: Definitely.
Speaker 2: And we already mentioned the liquidity limits.
Speaker 1: Having your money locked up for years just isn’t practical for most people building wealth who might need access to their funds.
Speaker 2: So for most listeners, especially younger investors or those in the accumulation foes, this edition suggests focusing elsewhere first.
Speaker 1: Like what?
Speaker 2: Like gaining experience, building a solid foundation, and maybe exploring more accessible alternatives.
Speaker 1: Things like certain ETFs or mutual funds that are inspired by hedge fund strategies, but without the crazy minimums and lockups.
Speaker 2: OK, so direct investment is probably off the table for most.
Speaker 1: But you said there are lessons.
Speaker 2: For those who can invest, why do they do it?
Speaker 1: And how can the rest of us maybe apply those underlying ideas?
Speaker 2: Great question.
Speaker 1: For those with significant capital, this edition lays out several core advantages that explain why they invest.
Speaker 2: And yes, these principles are valuable for anyone managing wealth.
Speaker 1: First, diversification.
Speaker 2: Hedge funds often invest in ways that don’t correlate strongly with traditional stock and bond markets.
Speaker 1: This can lower overall portfolio volatility.
Speaker 2: So they zig when the market zags, potentially.
Speaker 1: That’s the idea, yeah.
Speaker 2: Reducing overall risk.
Speaker 1: For anyone, the lesson is to think broadly about diversification in your portfolio.
Speaker 2: Are all your assets moving together?
Speaker 1: Maybe look at adding things like real estate, perhaps through REITs, or other alternatives that behave differently.
Speaker 2: Makes sense.
Speaker 1: Don’t put all your eggs in one correlated basket.
Speaker 2: Exactly.
Speaker 1: Second, active management.
Speaker 2: You have skilled professionals actively trying to navigate markets and find opportunities, especially when things get choppy.
Speaker 1: The takeaway for you, be actively engaged with your own investments.
Speaker 2: Don’t just set and forget forever.
Speaker 1: Review, rebalance, stay informed, especially in changing markets.
Speaker 2: So be your own active manager in a sense.
Speaker 1: In a sense, yes.
Speaker 2: Third, uncorrelated returns.
Speaker 1: We touched on this, but the goal is performance that’s independent of the market.
Speaker 2: This adds stability.
Speaker 1: For you, it means seeking out investments or strategies that can potentially do well, even if the S &P 500 is having a bad year.
Speaker 2: Maybe it’s certain types of bonds, alternatives, or specific sector bets.
Speaker 1: Smoothing out the right.
Speaker 2: Precisely.
Speaker 1: And finally, unique opportunities.
Speaker 2: Hedge funds can access niche markets or complex deals.
Speaker 1: The principle for you.
Speaker 2: Stay curious.
Speaker 1: As your knowledge and capital grow, be open to exploring less common investment types, maybe through specialized funds that are accessible.
Speaker 2: OK, so even if I can’t buy into a million dollar fund, I can still think like they do about diversification, active involvement, and finding unique return streams.
Speaker 1: That’s exactly it.
Speaker 2: It’s about applying the mindset of strategic risk managed investing to your own situation.
Speaker 1: This edition actually gives some pretty concrete actionable takeaways.
Speaker 2: What should listeners be thinking about doing now to apply these ideas to their own net worth journey?
Speaker 1: Yeah, it offers some practical steps.
Speaker 2: First, maybe explore those head fund inspired ETFs.
Speaker 1: These give you a taste of strategies like global macro or long short at a low cost and with easy access like buying a stock.
Speaker 2: It’s a way to get exposure.
Speaker 1: OK, accessible entry point.
Speaker 2: Second, Maybe test alternative assets with small amounts.
Speaker 1: Try re-ETF or real estate exposure or look into funds that offer access to private credit or infrastructure, if available and suitable for you.
Speaker 2: Just get comfortable with things beyond plain stocks and bonds.
Speaker 1: Dip a toe in, learn how they work.
Speaker 2: Great.
Speaker 1: Third, follow hedge fund trends.
Speaker 2: Just reading about how these strategies are doing, what’s working and what isn’t, helps build your market understanding.
Speaker 1: It’s good context.
Speaker 2: Stay informed.
Speaker 1: Fourth, expand your knowledge.
Speaker 2: Don’t shy away from learning about concepts like leverage, derivative, short selling.
Speaker 1: Even if you don’t use them directly now, understanding them makes you a smarter investor overall and prepares you for the future.
Speaker 2: Education is key.
Speaker 1: Absolutely.
Speaker 2: And finally, really assess your own risk tolerance.
Speaker 1: Understand how much volatility you can stomach.
Speaker 2: Use online tools, talk to an advisor, figure out if strategies that might behave like hedge funds fit your personality and your long-term goals.
Speaker 1: It really is powerful to shift the focus even without millions.
Speaker 2: Adopting that mindset strategic, diversified, risk aware seems incredibly valuable for building wealth long term.
Speaker 1: is.
Speaker 2: And it fosters that idea of proactive investing.
Speaker 1: It’s less about chasing quick wins and more about building a resilient portfolio that can compound steadily over decades, protecting your capital along the way.
Speaker 2: You know, it raises an interesting final thought.
Speaker 1: Hedge funds are clearly powerful tools for the already wealthy.
Speaker 2: But maybe the most profound lesson for everyone building their net worth isn’t about mimicking their specific trades.
Speaker 1: Perhaps it’s about embracing their discipline, their relentless focus on protecting capital, managing risk and understanding the impact of costs like those high fees.
Speaker 2: True growth comes from that strategic protection as much as from the gains themselves.
Speaker 1: That’s a great point.
Speaker 2: So the question for you, the listener, is are you thinking strategically enough, not just about how much you can make, but how effectively you can protect and compound what you have, even if you’re starting small one dollar at a time?
Speaker 1: It’s about applying that professional rigor to your own financial future.
Speaker 2: Remember to subscribe to Noyack Wealth Weekly on our website.
Speaker 1: We are wearenoyack.com.
Speaker 2: To read the article behind today’s conversation and to get our weekly newsletter straight in your inbox.
