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Day 138 in MIT Sloan Fellows Class 2023, Financial Market Dynamics and Human Behavior 5 - "Hedge fund"

MBA MIT SFMBA finance

Hedge fund

Hedge fund is the unique and interesting player to help you understand the physics of Adaptive Market Theory.

 

Hedge fund:

  • Pools capital from investors.
  • Uses diverse strategies for high returns.
  • Charges performance and management fees.
  • Key role in the financial industry
    • During normal times, "tip of the spear"
    • During hard times, canary in the coalmine
  • As unregulated entities, hedge funds innovate rapidly
  • Due to leverage, hedge funds have disproportionate impact on markets

 

Hedge fund vs. Venture Capital (VC):

Hedge fund: invests in diverse assets, including public markets.
VC: invests in early-stage, high-growth startups.
Hedge fund vs. Private Equity (PE):

Hedge fund: short-term trading, complex strategies, higher liquidity.
PE: long-term investments, operational improvements, leveraged buyouts.
Hedge fund vs. Bank:

Hedge fund: investment focus, risk-seeking, caters to high net worth clients.
Bank: provides loans, deposits, payment services, caters to diverse clients.
Hedge fund vs. Broker:

Hedge fund: actively manages investments, takes risks for higher returns.
Broker: facilitates transactions, earns commissions, does not manage investments.

 

Galapagos Island of Finance

Why does evolution occur so rapidly among hedge funds?

  • Relatively low barriers to entry and exit
  • High levels of compensation(stakes are high)
  • Competition and adaptation are extreme
  • New "species" are coming and going constantly
  • Strategies wax and wane over time:
    • credit strategies are waxising
    • Dedicated short bias is waning
  • Empirical evidence for adaptive markets hypothesis

 

Legendary hedge funds

George Soros:
George Soros, the "Man Who Broke the Bank of England," founded Soros Fund Management in 1970. Born in Hungary, Soros survived the Nazi occupation before emigrating to England, where he studied at the London School of Economics. A brilliant investor, Soros has a unique ability to identify macroeconomic trends and profit from them. His most famous anecdote is the 1992 Black Wednesday event when he bet against the British pound, forcing the UK to withdraw from the European Exchange Rate Mechanism. Soros made over $1 billion in profit within a day, solidifying his reputation as a legendary investor. His investment philosophy, combining macroeconomic analysis with market trends, has helped him navigate complex market conditions and consistently generate high returns.

 

 

James H. Simons:
James Simons, a gifted mathematician and former codebreaker for the US government, founded Renaissance Technologies in 1982. With a background in academia, including a professorship at MIT, Simons had a unique perspective on finance. He pioneered quantitative trading, using complex mathematical models and algorithms to make investment decisions. The Medallion Fund, the firm's flagship, has become one of the most successful hedge funds in history, with annualized returns of over 66% before fees since 1988. An interesting anecdote from Simons' career is his decision to hire scientists, mathematicians, and even astronomers, rather than traditional finance professionals, to build and refine his quantitative models. This unusual approach and the secretive nature of Renaissance Technologies have contributed to the firm's outstanding performance and legendary status in the finance world. His fund never become the size over $5B because he knows the maximum capacity to keep his investment performance and prioritize performance over the size.