Why do people invest in hedge funds?

Correct me where wrong, but I was under the understanding that 85% of them don't beat the market, so what's the point?  I'm not sure if that number is before or after fees though, I know they're quite hefty (2% + 20% carry if I recall is the rule of thumb).

You think a giant hedge fund is the same as one guy trading? 

They have the resources and algorithms 

They don't exist to beat the market when the market is good. They exist to take contrarian/high risk positions that explode with profits if a particular, unlikely, set of circumstances occurs.

For example, say your portfolio is heavily invested in the energy sector. You take a small portion of your liquid assets, no more than 10 percent, and invest with a hedge fund manager.

Then Covid-19 happens, no one is driving cars, and crud oil drops to $5.00 a barrel. Most of your portfolio is wiped out (on paper).

But your hedge fund manager is heavily invested in July $50 Puts. Suddenly every $5000 that he had "hedged" for you is now worth $50,000. This gain makes up for the paper loss you experienced in your portfolio.

But the hedge fund manager realizes that the lockdown is temporary, so he sells the $50 July Puts and buys July $6.00 Calls.

In May the lockdown is lifted. People start driving cars again, and demand drives crude oil to $26 a barrel. Now each of those $50,000 worth of Calls is worth $150,000. Also, your portfolio of energy stocks has mostly recovered.

This isn't something that will happen every year, or even every five years. Most of the time that 10% of your portfolio will ebb and flow, and mostly over time diminish and you will have to replenish it. And then out of the blue you have doubled your account.

For the very wealth, who can put three more zeros at the end of each of those example numbers, it only needs to happen once a decade or so to make them set for life.

Seriously, I've read several biographies of successful hedge fund managers. EVERY SINGLE ONE of their success stories began this way - "I had a friend who lent me ten million dollars..."

Junnk -

You think a giant hedge fund is the same as one guy trading? 


They have the resources and algorithms 

Again though, unless the number I got is/was wrong, the overwhelming majority don't beat the market.

Because rich people feel the need for premium products and services.  It's unfathomable to them to that they can't beat the low fee index funds that the plebs use.  So they pay some guy to make them feel special and lap up his yearly excuses as to why he underperformed the market.

phydeau - They don't exist to beat the market when the market is good. They exist to take contrarian/high risk positions that explode with profits if a particular, unlikely, set of circumstances occurs.

For example, say your portfolio is heavily invested in the energy sector. You take a small portion of your liquid assets, no more than 10 percent, and invest with a hedge fund manager.

Then Covid-19 happens, no one is driving cars, and crud oil drops to $5.00 a barrel. Most of your portfolio is wiped out (on paper).

But your hedge fund manager is heavily invested in July $50 Puts. Suddenly every $5000 that he had "hedged" for you is now worth $50,000. This gain makes up for the paper loss you experienced in your portfolio.

But the hedge fund manager realizes that the lockdown is temporary, so he sells the $50 July Puts and buys July $6.00 Calls.

In May the lockdown is lifted. People start driving cars again, and demand drives crude oil to $26 a barrel. Now each of those $50,000 worth of Calls is worth $150,000. Also, your portfolio of energy stocks has mostly recovered.

This isn't something that will happen every year, or even every five years. Most of the time that 10% of your portfolio will ebb and flow, and mostly over time diminish and you will have to replenish it. And then out of the blue you have doubled your account.

For the very wealth, who can put three more zeros at the end of each of those example numbers, it only needs to happen once a decade or so to make them set for life.

Seriously, I've read several biographies of successful hedge fund managers. EVERY SINGLE ONE of their success stories began this way - "I had a friend who lent me ten million dollars..."

This is good info.  So it's kind of like the venture capitalist approach, where they make a bunch of small bets they expect to fail, and then hope one pays off absurdly

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