Hi everyone. I am Mike Gasior and this is my December 2006 video commentary. I hope you guys have had great Halloween and a good new year and now 2007 is kicking off and I am going to keep up the same trend I have been going for the last couple of years which is making each of these months topics several little mini seminar in itself. And I said in my newsletter, this month was going to be just sort of primer about hedge funds.
I have had hedge funds as client for. I hate thing and this is now over 20 years and I still trying, even as gigantic as the markets gotten for them. Because if you don't know, that's anyone could estimate there is about 8000 to 9000 different hedge funds being run worldwide, managing about 1.3 trillion U.S. dollars. They become a monster force in a financial markets and most of main-street doesn't know much about them. And I thought I just give you the basics.
Now number one, a hedge fund really is very much like a mutual fund. It's a pooled investment vehicle where an investment manager, professional takes other investors money, manages it via some style and there are variety of styles. And like mutual fund managers while they charge you a management fee, it's typically 1 to 2%. Although, there are others charging more nowadays.
But let me sort of trace this backward, because while I always want to make that comparison to mutual funds there are some stark differences and the whole thing can be trace back about 50 years to a guy by the name of Alfred Winslow Jones. His friends called him Fred Jones. The stock market period that I am talking about 50 years ago was very much like the stock market we have been experiencing the last six years. We are really isn't doing much of anything. It's sort of turning sideways. Very difficult to really make money from times and markets like that but as per Jones guy, he had an idea, and his idea was simple and any of you have been in my classes will recognize this example because I use it all the time.
To put it let's say in a modern terminology. Let's just say that I am looking at Ford Motor Company and General Motors common stock. And this is just a fake opinion but let's just say that I think GM has really gotten beaten up and off a lot and Ford just hasn't taken nearly the same amount of medicine. So here is my idea. I am going to go short the Ford stock which I don't think has been really hurt that bad and I am going to go long GM. So I am talking about short Ford, long GM.
Now if I ask you what my position is now in the stock market. You would describe it is neutral. Which if you ever hear a portfolio manager describe their philosophy as being market neutral that's what I just did. I am long ones stock and short the other one. But what I have done is I have isolated my difference of opinion between GM and Ford because they did both go straight in the tank from here. All I need is Ford, the one that I shorted to go down more than GM or they could go both straight up.
As long as General Motors, the one that I went long goes up more than the Ford. So that's toward the essence of market neutral and that also where that name sprang from, hedge funds. Now in previous discussions I have talked about how derivatives get used for hedging. A real hedge with derivatives would be an example of a corn farmer, who in real life is long corn, going short the corn in futures. That's what hedging is all about and that's where that name sprang from. Because the initial hedge fund marketplace was that simple long, short strategy.
Now there is problem. For Alfred Jones fellow. His idea long ones stock and short the other was not allowed and to this day really isn't allowed to be done in a mutual fund. So he had to come up with another idea and his was create an investment vehicle that does not have to be registered like mutual funds do with the Securities Exchange Commission. And what either side you would do is sell interest in his fund only to either accredited individuals or institutional investors.
The important where there are -- and I am talking in a U.S. centric kind of way is the accredited investor, which is there is two thresholds that could be met as an individual. Either you could show me you have $200,000 of income for the last couple years, filing single or 300,000 filing joint. Or it's good as that is if you could show me that you have a one million dollar net worth minus your primary residence, either qualification will make you accredited and allow you to participate in private placements of securities which is what we are talking about.
Your typical hedge fund is structured usually as a limited partnership and you would be a limited partner investor in let's say Mike's Hedge fund. I am the general partner and I am the one running the money. So because the hedge fund is arranged in this private way and not regulated under the SEC, they could do this long and short thing. The irony also is the name is a misnomer because even though they say hedge funds, typically when a hedge fund uses derivatives it's almost never for hedging.
Hedge funds almost exclusively use derivatives for speculation and now there are a million different strategies being pursued by hedge fund managers. Not just that long and short, they can do just long, just short, speculate in the commodities market. Any number of things and they are investing a some of the wildest stuff on earth.
So there is one thing Fred Jones want to do but let me mention another thing. Another thing he wanted to do was take a share of the profits. You wanted to take a 20% share of any profits. So 80% of the profits go to the investors in hedge funds, you guys. The 20% of the properties stay with me, the hedge fund manager. Now that one or two percent management fee that I took, that typically just covers my overhead, my rents and heat, and hot water and electricity and coke machines and so on.
I don't really start making money until I am participating in some of that 20% action. But the thing is the SEC does not allow that in mutual funds either. They do not allow the manager to participate where there's profits. So those two things are; Number one, that the hedge fund is only available to these either wealthier, well to do individuals, or institutions and at the manager shares in the profits. And I know that seems like a big share. But it really holds the manager speak to the fire because they really don't make money unless the fund is profitable and they will do anything, anything they have to do to get into that profitable situation, when year ends or whenever the 20% cut time comes.
So those are the primary differences and I just wrote it in the newsletter just passed that on an average gain of 30 to 35% of all the trading at the New York Exchange is hedge fund related and sometimes up to 40% on the London Stock Exchange and one guy Steve Cohen who owns SAC which is Steven A. Cohen Capital down at Greenwich, Connecticut. On a daily basis, his trading operation alone out of Greenwich almost 2% of the New York Stock Exchange and the NASDAQ volume. So it's an enormous segment of the business.
Those are the basics. I may come back in other commentaries and we will talk more about it. So you know what's kind of cool, I am sitting here and just be honest with you, it is January 6th. It is 67 degrees in Connecticut. This is the view of my backyard and I can't believe it. I am wearing a turtle neck. It's almost too much. I hope all you guys have been well. I am excited about the New Year 2006 was great along with that you can, next month we will talk about something timely. Now pick it on the fly. Hope you are all well. I will see you again soon.
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