Reducing volatility from investing with hedge funds in order to relax
One of the benefits of working at an investment bank is gaining access to a variety of investment opportunities that retail investors normally wouldn’t have access to. For example, if Goldman Sachs decided to create a special opportunity fund for institutions because they saw opportunity in the Argentinian debt market, employees would have the opportunity to invest alongside some of the world’s largest money managers like Fidelity, Capital, and Franklin Templeton. Random investment opportunities came up all the time.
After two years as a financial analyst at GS in NYC, I knew my days were numbered as the NASDAQ dotcom bubble burst in March 2000. I remember optimistically telling my VP in May 2000 how I was still bullish on the markets and he sternly told me, “We’re in a bear market. Stop kidding yourself.” Three years later, more than half of my analyst class was let go.
By June 2000, it was clear the NASDAQ was not getting better. I can’t remember exactly how things played out, but I think management sent out an internal e-mail to all employees about how we should keep focusing on our clients – that now was the best time to give them a call or take them out because nobody else was. In the employee memo, management also indicated they had added some new options to our 401k retirement plan, namely several hedge funds that looked to profit from the downturn.
Given some of our smartest and most profitable clients were hedge funds, I decided to do some research and invest half of my 401k into a technology hedge fund, Andor Capital Management, founded by Daniel Benton. Andor was one of Goldman’s largest clients, and they formed some type of partnership where they would let employees invest without needing the $1 million+ minimums. The flagship Andor technology fund ended up returning 35 percent in 2000, net of fees, and my 401k actually inched up in 2000 and 2001 as a result of the hedge fund investment instead of getting slaughtered.
I kept my GS 401k until 2003, despite moving to a new firm in June 2001, due to the investment selection. But after it felt like the markets were out of the woods, and since I could no longer contribute to my GS 401k hedge fund as an ex-employee, I consolidated my 401k balance at my new firm to keep things streamlined.
WHY INVEST IN A HEDGE FUND?
After my positive experience with Andor Capital Management, I never had the opportunity to invest in another hedge fund again. I didn’t have at least a million dollars to invest, nor did I have close friends who ran their own successful hedge funds who could invite me in at a lower minimum. My lack of funds and connections were unfortunate because I could have preserved a lot of capital during the 2008-2010 downturn, just like I did in 2000-2003. Instead, I lost about 35% of my net worth within a year in 2009, which led me to start this site as
a way to deal with the pain.
When the housing market crashed in 2008-2010, John Paulson made his hedge fund $3-4 billion as he was long CDS (Credit Default Swaps) insurance that rose in value as CDO (Collateralized Debt Obligations) mortgages fell with the housing market. John became a billionaire overnight, and is known for making one of the best trades in one of the most difficult environments ever. He proceeded to lose money going long gold, but he’s still a billionaire. There are opportunities to make money in any environment, especially if you run a hedge fund that can go long or short securities.
As someone who has spent 16 years after college building my net worth to the point of achieving financial freedom. the last thing I want to do is lose any significant amount of money. If I lose 50% of my money, it takes a 100% return just to get back to even. As a result, I’ve been consistently investing in structured notes since I left Corporate America in 2012 because they provide downside protection in return for giving up some of the upside, e.g. no yield, or a 95% upside participation rate instead of 100% for 20% downside protection over five years.
The main reasons why I want to invest in a hedge fund are:
1) Capital preservation during volatile or bear markets. Money is meant to serve its owner, not the other way around. I never want to lose sleep again when the markets are taking a dive. I want my fund manager to lose sleep because he is up every night thinking about the best ways to manage risk. After you build a large enough nut, the goal is to grow it in a prudent way where it can last for as long as possible. I understand the importance of beating inflation, and personally shoot for a 3X rate of return on the 10-year yield in a risk-adjusted manner.
2) The ability to still make a positive return during bad times. So many people think they are investment geniuses in a bull market. I’ve invested through three downturns, and I can promise you that difficult times will come again. Sure, you can buy and hold forever, and probably turn out OK. But there will be a point where you’ll want to utilize your capital for life. Hedge fund managers are paid based on the expectation of making money during good or bad times. Losing money, but outperforming an index is not good enough over the long term.
3) Diversification. Hedge funds and other alternative investments aren’t a 100% replacement for your plain vanilla index and ETF funds. I am a strong believer in asset allocation and having a core of 60-90% of your investments in index funds. They are low cost and are the easiest way to provide the exposure you want to equities, which have traditionally increased by 6-10% a year. For the remaining 10-40%, I’m seeking alpha or looking to hedge based on the two points above. The issue was never having access at levels I could afford, until now.