Hedge Fund vs Mutual Fund, Understanding The Differences
April 1, 2010 09:26pm
Hedge funds and mutual funds have many similarities, but many differences
exist as well. Know the benefits of each before making the decision to invest.
In 1949 Australian Alfred Jones was credited with the term "hedge fund".
Historically it derives its name from the use of hedging to manage risk while achieving
superior returns. Today, a hedge fund is an un-regulated investment vehicle designated
for sophisticated, also known as the "Accredited Investor".
Mutual funds gained popularity in the 1980's. Prior to this time, the problem
of the small investor was in obtaining sufficient knowledge to make informed investment
decisions, and so the average person avoided stock market investing. Instead money was held
in traditional savings accounts or placed with a bank in a Guaranteed Investment Certificate
("GIC") or Certificate of Deposit ("CD").
What to do. The small investor was not able to obtain a professional money
manager without $10 million or more to start. But what if he could pool his money with
other small investors to reach this minimum threshold. And so the mutual fund was created
to address these exact concerns.
The mutual fund concept was simple, allow the un-sophisticated investor access
to the strategies of the professional money manager. This was done by pooling small sums of
money, as little as $20.00 deposited monthly. In return, the fund company would use professional
money managers using professional investment strategies to easily out perform traditional
bank savings products.
The mutual fund investor had other problems. Because they did not understand
the nature of the investments made for them, government regulators got involved to protect
investor rights. And so mutual fund investing became regulated and soon took on a life of
its own. Rules were set in place to govern what could be held within a mutual fund and how
the investment strategies were marketed to the public. Even what could be invested and what
should be avoided.
While much evolution has transpired since the early days of the 80's. One
thing is for certain, mutual fund investing is all about what it cannot do. While this
article is not focused on these issues, there are some glaring examples the investor needs
to know. In times of market un-certainty, the mutual fund cannot sell and move to cash for
safety. The manager must remain fully invested at all times making the investor, in
consultation with his Investment Advisor, responsible for proper asset allocation. The mutual
fund also cannot employ risk management or hedging techniques because they are deemed too
sophisticated for the small investor to understand. So to avoid investor complaints, these
important strategies are discouraged by managers and outlawed by regulators.
In the end, all of the benefits started by the mutual fund industry to
provide safety of capital have been regulated away from the interests of the small investor.
In fact, these are the exact investors which need safety of capital most of all. Many
market observers believe the industry has become over regulated and as such, do more
harm than good.
To-date, the hedge fund industry has been able in all country jurisdictions
to avoid nuisance government meddling. The recent wall street initiated financial melt
down has proven that even a self regulated industry is not immune. It seems big company
rights take precedence over investor rights. So some regulation may be forth coming.
Historically, the hedge fund industry has been able to avoid regulation by offering its
products only to the Accredited Investor. There is a strict agreed upon formula based
on wealth accumulation. The premise being if you were smart enough to accumulate wealth,
then you are smart enough to understand the sophisticated investments being recommended.
Typically hedge fund investors are in direct contrast to mutual fund
investors and thus have different needs. The mutual fund investor has modest wealth
and little investment knowledge. The hedge fund investor has significant wealth with
greater investment understanding. Therefore one is regulated to protect the investor
and the other is not.
The above description is not the only difference that separates the two.
Hedge funds can employ a complex strategy of investment vehicles known only to the
fund manager. Many hedge fund managers are protective of any proprietary trading
formula which will provide an edge over their competition and disclosure of their
trading style is not required.
Mutual funds are sold through an Investment Advisor who will make
comparisons, explain and make recommendations for a balanced portfolio. Hedge fund
investing can be more difficult. Firstly, there can be difficulty in locating a list
of the availability of funds. There are however helpful data-bases for this. Then
you must undertake your own due diligence to ascertain if it is the right asset mix
for your overall portfolio.
Thirdly, you'll need to have an understanding of the different
investment strategies. Do you choose a value fund or a growth fund.
CTA funds
are out performing these days and what about a suitable bond fund. Does my fund employ
hedging and should I invest in an off-shore fund to obtain the tax benefits.
There are certainly many things to think about when selecting the proper
investment vehicle. Make your selection with intelligence and proper planning. Ask
around and be inquisitive. Your level of investment knowledge and the time needed to devote
to this topic will dictate which is best for you.
Dwayne Strocen is a registered Commodity Trading Advisor specializing in analyzing and hedging Market
and Operational Risk using exchange traded and OTC derivatives.
View more detailed information about his CTA funds
and Who We Are .
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Transparency In Hedge Fund Investing Is Critical For Investors
November 21, 2009 19:47pm
Due to some recent high profile fraud cases within the hedge fund industry, many investors are seeking greater transparency from their investment managers. While many managers protect their proprietary trading programs, there is one sure fire way to address this issue.
Fund redemptions are nothing new. Every recession or bear market sees investors redeeming their fund investments and moving to asset classes which provide a greater degree of safety. For most, this is the Government Treasury Bill also called the T-Bill.
While reasons for redemptions are as varied as the investment selections themselves, it seems that individual investors are uncertain of their understanding of what their money has been invested in. While mutual funds are marketed to the investor with a lower knowledge of investment products, the hedge fund has always been the investment choice for more knowledgeable investors or the "Accredited Investor". But now it seems even this group is calling for the need of greater understanding from their investment managers.
The battle for returns which out perform the index has resulted in many Portfolio Managers refusing to disclose their trading program for fear others will duplicate their trading style. It is said by many managers that it's this ability to observe unique characteristics in the market place that differentiates their funds performance from the typical returns generated by bottom quartile performing funds and fund managers. Of course the unregulated hedge fund industry has perpetuated this myth by trusting the Accredited Investor with an above average knowledge of the market and his ability to select the correct investment for their portfolio. It seems the Accredited Investors does not always posses greater knowledge than their more un-sophisticated mutual fund brethren.
So that bears the question of how to obtain this transparency to the satisfaction of the investing public? And the answer is the Managed Account.
Managed Accounts are simply individual accounts opened in the name of the investor. These accounts are not pooled, yet they are identically structured and managed by the hedge fund Portfolio Manager in the same style as the pooled fund. The critical difference is the investors ability to see every trading transaction performed in the account by the fund manager.
The popularity of the pooled investment structure is that investors do not have to deposit large sums of money to utilize the services of a professional Portfolio Manager. Most successful professional Portfolio Managers do not accept accounts less than US$10 million dollars.
The hedge fund and mutual fund gained popularity by allowing smaller sums of money to be pooled with other deposits from many other investors. So while you can currently participate in a hedge fund investment for $100,000, and a mutual fund for $50., a managed account may require a minimum investment in excess of $1 million. Not so good for everybody.
But lets suppose you can convince your hedge fund manager to accept your $100,000 what advantage do you gain.
There are also some disadvantages. Or put another way, the pooled investment structure provides some distinct advantages which originally made them popular since the first hedge fund was created in 1949. These funds should not be confused with the investment account managed by your stock broker. The professional Portfolio Manager will continue to exercise complete trading autonomy and does not want your advice on how to manage the assets in your account.
Advantages for remaining in a hedge fund or mutual fund:
- investors can obtain the services of a professional fund manager with smaller sums of money;
- management costs are cheaper since it is more economical to manage one large account instead of many smaller accounts;
- you pay one flat management fee, no commissions; and best of all
- you still have someone to blame if things go wrong.
It is estimated that the hedge fund industry managed $2.7 trillion dollars by the end of 2008. The mutual fund industry manages $19 trillion investment dollars. So there is no question of the popularity of the industry since that first fund in 1949.
If transparency is an issue for you, you need to take a long, hard look and evaluate the pros and cons wisely. Take some time to speak with your fund manager about a managed account, it just might be the alternative you've been looking for.
Dwayne Strocen is a registered Commodity Trading Advisor specializing in analyzing and hedging Market and Operational Risk using exchange traded and OTC derivatives.
View more detailed information about his Managed Account program and about trading greenhouse gases.
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Consider A CTA Managed Fund For Balanced Asset Allocation
August 27, 2009 19:14pm
There are many investment strategies for both the novice and sophisticated investor. The CTA managed fund has been overlooked until recently. Now the top performing investments are managed by CTA's and you should consider including these in your portfolio.
You might be wondering what a CTA is. A CTA is a Portfolio Manager for derivative products such as foreign exchange, commodities or futures. If you're familiar with traditional mutual funds or hedge funds, you'll know the investment decisions are made by a specialist in stocks or bonds. These are also called equity and fixed income products.
An equity fund is managed by an equity Portfolio Manager known as a CFA and a bond fund is managed by a fixed income Portfolio Manager also a CFA. Their exists a third type of Portfolio Manager and that is one responsible for managing a fund which is invested in products like currency, carbon emissions, precious metals, agriculture products and others. These Portfolio Managers are known as CTAs and they manage CTA funds sometimes known as a Managed Futures Fund.
Despite the obvious, each investment style has its own unique characteristics. For example, a traditional equity investor only makes money when the stock market is rising. They lose money during a falling or bear market. Wouldn't it be fantastic to win no matter which direction the market went. Well that is exactly what happens in a CTA fund. The CTA can buy or sell at random. We call this being "long" or "short". When long, you're betting the market is going up and when short, you're betting the market is falling. A CTA makes money no matter which direction prices are headed.
Now that you know the basics, lets look at why CTA funds have out performed equity and bond funds. Since September 2008 the wall street induced sub-prime mortgage fiasco has caused stock prices to plummet. If you held an equity mutual fund or a stock portfolio of your own, you will have lost money. In fact since Sept 1, 2008 the Dow Jones Industrial Average has lost 20.36 percent. According to the Managed Futures CTA database, the average CTA Fund YTD ROR (Rate of Return) to June 2009 is +2.14 percent. That's a whopping difference of 22.50 percent. These funds are definitely worth looking at.
A major advantage is the ability to trade the underlying commodity product. Why buy a company that's involved in oil extraction when you can buy the oil itself. The reason why stock market investing becomes difficult, is the many different factors that come into play. There is the ability of management, economic pressure, competitive pressure, union demands, changing consumer habits and a host of other factors that determine the profitability of a company.
A CTA fund has none of these issues to contend with. Investors who purchase Aluminum or High Grade Copper on the New York Mercantile Exchange are affected only by issues of Supply And Demand. During economic periods of growth, prices rise and during periods of recession, prices fall. So while your equity fund is sitting on the sidelines waiting for a market re-bound, the CTA fund is profitably trading a falling market.
I would be remiss if I did not discuss the use of leverage. Unlike an equity fund, A CTA fund uses leverage. For example, to purchase $100,000 Canadian Dollars cost only $350 to the CTA. So when the dollar rises from 91 cents to 92 cents, the fund makes a profit of US$1,000. That equates to a 186 percent profit. If we look at this from another angle it might become clear. To purchase 1,000 barrels of crude oil at US$60 per barrel would cost US$60,000 to the cash consumer. The NYMEX charges a deposit, we call this margin, of US$6,000. Should Crude Oil rise to $65 dollars, the profit is $5,000 or 83 percent profit.
Of course, the use of leverage can be dangerous as losses can quickly escalate. Should Crude Oil have fallen to $55 instead of rising, a loss of $5,000 would have resulted. Of course, CTA funds are not the only funds to utilize leverage. Many equity hedge funds use leverage routinely and depending on your overall investment objective a balanced asset mix will dictate the percentage of your portfolio allocated to such a fund.
There are many types of CTA funds to select from. Agriculture funds, energy funds, foreign exchange funds, index funds, fixed income funds and greenhouse gas or global warming funds. Choose the one that's right for you, but when balancing your investment portfolio don't over look this important sector for proper and complete asset allocation.
Dwayne Strocen is a registered CTA, Portfolio Manager. He manages the Global Climate Fund, an environmentally friendly hedge fund focused on the reduction of greenhouse gases.
View more information about CTA funds and trading greenhouse gases.
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The Role Of A CTA, Commodity Trading Advisor
June 11, 2008 7:00am
Today's Commodity Trading Advisor is no longer to be thought of only as a Portfolio Manager. His role has expanded considerably as investment products become more complex.
Commodity Trading Advisor, Genuine Trading Solutions, a registered CTA with the CFTC, says the responsibility today of a CTA is a constantly evolving role in today's market place.
Once upon a time a Commodity Trading Advisor was content to be known as a Portfolio Manager trading commodities and futures for a managed futures fund. There is no question today's investor has become more sophisticated. In response, today's selection of investment products has become ever more complex and varied, the need for the CTA to understand the uses and management of these products becomes even more acute.
So what exactly is the role of today's Commodity Trading Advisor. Certainly trading of derivative products for a managed futures fund continues to be as important as before. A CTA has also become more involved with derivative analytics. This role is essentially focused upon becoming an analyst to structure and analyze the more multi-faceted requirements demanded by hedge funds, pension funds and structured products.
The use of derivative analytics to manage the adverse risk of an equity or bond portfolio brought about by adverse market conditions is critical in preserving asset growth. The uses of hedging to prevent volatility has long been understood by the largest institutions but is now available to the smaller sized company and to the individual investor. No doubt as products continue to evolve so too will the CTA evolve to meet the need of today's professional money manager.
Derivative products are no longer limited to exchange traded commodities futures and options. There continues to be an ever expanding list of over-the-counter derivative products. These are SWAPS. SWAPS and privately transacted products transacted without the use of a recognized exchange. The difficulty is the buyer and seller must find each other to undertake such an arrangement, not always easy. The second problem is no liquidity. There is no one to sell this too should one of the parties wish to terminate the transaction prior to the agreed upon date.
A Commodity Trading Advisor's role is no longer sufficient to be limited to trading. It is now imperative to understand the industry in a new light so to understand the changing investment environment. Analysis now becomes the catalyst to include a value added service to retain customers. This includes structured products, risk management and OTC derivatives. Continuing education has been and continues to be the hallmark of the best in the industry.
Dwayne Strocen is a registered Commodity Trading Advisor specializing in analyzing and hedging Market and Operational Risk using exchange traded and OTC derivatives. Website: http://www.genuineCTA.com
View more detailed information on the role of a Commodity Trading Advisor and about Learning To Trade
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