Hedge Funds 101

What is a hedge fund?

A hedge fund is an investment vehicle which makes money by buying things and marking them up.

Wait--isn't that the same business model as my local supermarket?

Almost exactly! One tiny difference is that your supermarket actually has to sell the things they buy, while the hedge fund makes money just by marking them up.

Sort of like a hedge fund.

How do they do that? They can't just make up the prices, can they?

No, that would be illegal. They have to pay other people to make them up.

What if the hedge fund owns illiquid securities that trade only infrequently? How are those priced?

From January through November, the value of the portfolio is established by independent third-party pricing services and arms-length neutral practitioner input. Rigorous procedures are then applied to this outsourced data. These procedures require the application by highly educated professionals of a complex financial algorithm, or "model", which is based on the mathematical characteristics of the individual holdings.

OK, what about December?

That's called the "year-end mark", and it's determined in much the same way except that for year-end marks, the arms-length independent highly educated outsourced neutral third-party pricing data professionals employ a model that is based upon the compensation requirements of the hedge fund manager.

Pricing the year-end portfolio.

So what are these “things” that hedge funds buy?

Hedge funds mostly buy stocks, which are certificates that represent the underlying equity of a company; bonds, which are notes that represent the debt of a company; and derivatives, which are table napkins that represent the life savings of the hedge fund’s investors.

What’s so special about a napkin?

Nothing, until the hedge fund manager gets drunk and scribbles on it.

Such as?

"I, Chip 'Buzz' Chipley (hereinafter "CBC", "Buzz", or "Chipper"), manager of the Purple Haze Global Do Whatever I Want Fund ("PHGDWIWF", or "The Fund", or "Chipper's Piggy Bank"), hereby wager 100 million dollars ($100,000,000) of PHGDWIWF investors' money, which doesn't include any of My Own Money ("MOM"), that Mortgage Interest Rates As Published By The Federal Housing Authority ("MIRAPBTFHA") will rise by 1 percentage point Before Next Friday ("BNF"). It is hereby stipulated that even if I lose this bet and my fund blows up, I will get a better job and I Will Be Paid Even More Next Year Than I Was Paid This Year ("IWBPEMNYTIWPTY")."

Trading derivatives.

What’s with the acronyms?

Often only a small cocktail napkin is available.

Who’s on the other side of the bet?

Somebody that the hedge fund manager has just met at the jello-shot counter at a big hedge fund party, thus referred to as a “counter-party”. The counter-party might be another hedge fund manager, or it might be anybody who has a hundred million dollars, a napkin, and a missing frontal lobe.

How does the hedge fund manager know that the counter-party will pay up if he loses the bet? And vice versa?

Our capital markets and our entire financial system are built on a foundation of trust and integrity. Hedge fund managers would rather lose their hundred-million-dollar jobs than suffer the private disgrace of having failed to live up to a contract. Ultimately, for hedge fund managers, personal honor and doing the right thing are far more important than financial gain. No hedge fund manager would ever renege on a trade, not even a trade that loses a fortune.

Hedge Fund Manager Role Models

What if he thought he could get away with it?

Sorry, but you can't put a price on integrity. If you could, it would be around $20 million.

Do hedge funds deliver good long-term performance?

Quarter after quarter, year after year, hedge funds realize consistent above-market risk-adjusted returns.

What are stars?

Stars are little holes in the tapestry that covers the sky.

And hedge fund investors--- do they do well?

Investors in hedge funds always get wealthier thanks to the better-than-market performance of hedge funds.

Always?

Yes, unless they actually need their money back.

Hedge Fund Investors Cash Out.

What's the procedure?

Hedge funds follow a standardized process for investor liquidity. On the first rainy Thursday following any total solar eclipse in a year in which the NFC team wins the Super Bowl by more than three touchdowns (including two safeties), the investor may send a handwritten letter to his Congressman, along with a check to cover "incidentals", requesting a withdrawal of his hedge fund investment. The Congressman then writes the investor's request into pending environmental legislation. Once the bill passes Congress, it goes to the states, which have seven years to approve the request. Following such approval, the House Bursar instructs the Comptroller of the Currency to cut the investor a check for his full participation in the fund less any travel expenses incurred by members of the House Finance Committee and less management fees (typically lower than 100%).

Sounds complicated.

It is. That's why the Securities And Exchange Commission working with the City of New York recently developed a streamlined liquidity process which requires only that the hedge fund investor volunteer as a live target for NYPD taser practice.

Check's in the mail!

Are hedge fund managers really as smart as they are rumored to be?

Yes. Three facts: 1) Bill Gates started Microsoft because he couldn’t get a job at a hedge fund. 2) Hedge fund analysts who make mistakes are often demeaned by being forced to sit on a high stool in the corner wearing a cone-shaped cap that says “MIT Physics Professor” on it. 3) When legendary rocket scientist Werner von Braun screwed up, his colleagues would mock him by saying, “Von Braun? Ha! He's no hedge fund manager."

"Great ideas--Phlogiston. Ether. Subprime CDOs."

OK, then how did the Bear Stearns hedge funds lose money?

They didn’t lose money; they just got “marked down”.

The Education Of A TGOG-er

Ever wonder how the best TGOG-ers got to be that way? You don't just wake up some morning in tenth grade and say, "Mom, Dad, I figured out what I want to do with my life. My ambition is to spend every weekday for the rest of my years on this great green planet sitting in a huge room with hundreds of other sociology majors from second-rate colleges who also have no marketable skills or self-respect. I will earn an ass-kissing black belt by sucking up each and every day to hyper-intelligent narcissists who would sooner lick a toilet seat than make eye contact with another human being. I will become a Grandmaster of incomprehensible financial jargon and I will develop the ability to speak for hours at a time without ever saying anything. I will operate a specially outfitted keyboard, a keyboard which features many buttons that I will never touch. Why? Because I will push only the same three buttons in the same sequence hundreds of thousands of times, and always to no effect. I will be told only after my retirement that my keyboard was not actually connected to anything. Should I ever somehow stumble into an actual transaction, I will be certain that the parties to that transaction have squeezed out any possibility of profit for me or my firm.

Mom, Dad, I want to sell high yield bonds to hedge funds."

"24" vs. 3Go1Go

"Chloe, get me Jack on the phone. Now!"

"Sorry, Tony, I can't reach him. Jack's gone dark."

Some bad shit's about to go down at CTU, and there's no way to get in touch with Bauer. Uh-oh. Looks like western civilization might have to take it on the chin, maybe for a ten-count this episode. Omigod, could it be??? Time for "24" fans to start with the serious nail-biting.

Not TGOGers, though, who would simply laugh off this manufactured TV crisis. The fact is that if you're a fixed income sell-side Bloomberg keyboard jockey who never uses anything but the Forward (3) button followed by the Go button (1), then you've been dealing every business day with a predicament similar to Chloe's, only on a massive scale.

Here's why: because every single person you ever try to reach has gone dark. There's nobody on your entire contact list that can ever be contacted, at least not by you. That's your unique occupational challenge: initiating and maintaining a dialogue with counterparties who have your Bloomberg ID on auto-delete. It's as if Chloe not only can't get Jack; she can't get Tony, Michelle, Kim, George Mason (before he's dead), Ryan Chappelle (ditto), Morris, Bill, Audrey, Wayne Palmer, or President Palmer, and Nina Meyers has just given her a two-minute warning before releasing an airborne STD at Dodger Stadium.

Let's say it's a summer Friday, and you've decided to "work" from "home". Unfortunately, you've left your Bloomberg "B" unit at your sales post. So you lob in a call to your assistant, instructing as follows:

"Chloe (make sure to substitute name of actual assistant), I need you to download my client list to my PDA. Now."

"Sorry, Jack (or whatever your name actually is), but you don't have clients, you have customers. Clients are people who commit to do a certain amount of business on an exclusive basis within a certain time frame. Clients pay fees, customers pay commissions. Law firms have clients. Advertising agencies have clients. But unlike clients, customers can shop everywhere, and yours do. Except they don't shop here, so you never get any commissions. Sorry, Jack. I can't help being honest."

"Don't get technical on me, Chloe. Just shoot me my list. I'm feeling an urge to reach out in a series of futile and pathetic gestures to a large group of aloof and uncaring counterparties."

Your job description is the same as Don Quixote's:

To dream the impossible dream
To fight the unbeatable foe
To bear with unbearable sorrow
To run where the brave dare not go.
To right the unrightable wrong
To love pure and chaste from afar
To try when your arms are to weary

And finally---perhaps when some hedge fund prodigy accidentally hits "2" (REPLY) while wiping up the keyboard germicide:

To reach the unreachable star.

Tele-TGOGing

Here at 3Go1Go World HQ, we like to say that we're about the future. The fact is that without recent advances in telecom and technology, TGOGing would still be only the wet dream of some sociopathic buy-side trader with a clinical abhorrence for actual human contact.

The telephone? Excuse us, but we think not. Because besides the obvious downside of having to listen to someone else speak (shoot me, please!), and worse, of having to respond by actually speaking oneself (rip out my internal organs with a machete and allow the vultures to pick at my wasted flesh while I lay dying under a blistering Arabian sun, please!), telephones can get so dirty and so germy. Ugghhh! What 25-year-old MIT astrophysics grad with his own Gulfstream V would ever let some infected handset make contact with the head that houses the billion-dollar brain? And for what? To listen to some useless drivel--"We like the homebuilders in here, our guy thinks the Fed is done for a while, crude is running into strong resistance at $135, blah,blah,blah"--rendered utterly incomprehensible by the unwashed Joizy accent of some Rutgers communications major? Gag me with an unstable uranium isotope.

TGOG's Next Frontier?

So, yeah, we understand the value of the technology. We get it. We're Americans, dammit, and we're not afraid to venture forth where no man has gone before. But we're a bit miffed that it took a company from Canada (ice hockey, Molson's, endless boredom---yes, that Canada) to come up with a solution for the burgeoning community of road-warrior TGOGers.



Imagine skipping out early (leaving that open notepad and that half-filled cup of still-steaming coffee on the desk before you snuck away was a good move), making your way to GCT, grabbing a 20-ounce Foster's just before hopping on to the 4:14, slouching down in your window seat, and--before the train even leaves the station, before you even pop open the can--you pull out your brand new Curve, fire up the Bloomberg client app, dash off a content-free message to 300 buy-side recipients who couldn't possibly give less of a shit, and get exactly the same response you'd get if you were still sitting in front of your PC and your $20,000/year Bloomberg terminal, i.e., vapor. And it all happens at the speed of light.

Now that's progress. Kudos, Blackberry.

Those Other Keys

Sharp-eyed TGOG'ers can't help but notice that, besides "3", "1", and "Go-Enter" (which, together, constitute the sustaining life force of today's fixed income salesperson), there are several other keys on the standard Bloomberg keyboard. Some of those keys are Bloomberg-specific, and seventeen or eighteen of them were probably intended to represent the letters of our alphabet.

Waste of space?

For TGOG-ing, though, those other keys are irrelevant. So then, what is that "L" doing there? How about "B"? And that double-sized "Shift" key? What's that about?

We don't actually know. We have seen the "K" key used occasionally by buy-siders as a courteous alternative to simply ignoring an incoming message. It's a thoughtful way for an unbelievably busy 25-year-old trading legend to tell some hapless relic: "I am aware of your existence, and I think that I would be sad for a few moments if you passed on. Or perhaps not."

Here's how it's done:
_____________________________________

Salesman's Message:

"Our analyst has changed his opinion regarding the big money center banks and investment banks. He now believes that they will all go tits-up in the next few days, and that they will take the entire financial system with them, which will cause massive bank runs and social violence on a scale not seen since the final days of Rome."

Buy-Side Trader's Response:

"K"
_____________________________________

Of course, some keys that once served the function of spelling out words like "Thank" or "You" have now fallen into disuse. What follows is an approximate timeline describing the evolutionary process whereby the grueling practice of indicating gratitude by painstakingly pecking out a complex two-word, 9-key response has been gradually replaced by the less stressful (and less time-intensive!) act of doing absolutely nothing to acknowledge the receipt of the message or even the existence of the sender:

Salesman's message:

"I begged our research department to compile that list you requested of all privately-owned Romanian animal feed companies with outstanding bank debt denominated in drachma. It took them three weeks. Eight members of our analyst team were captured, shot, decapitated, and eaten by diehard Ceaucescu loyalist guerrillas, but they got the job done. The report is attached."

Buy-Side Trader Response:

2003

"Thank You"

2004

"Thanx"

2005

"Tks"

2006

"Ty"

2007

"T"

2008

" "

"I'm Busy Right Now, Gotta Hop" (click)

Here at 3Go1Go World Headquarters (above), we are often asked how 3Go1Go came to achieve such prominence as a Bloomberg maneuver within the high yield sell side community.

The answer: Great social movements often begin with powerful ideas expressed concisely.

Churchill: "We shall fight on the beaches, we shall fight on the landing grounds, we shall fight in the fields and in the streets, we shall fight in the hills; we shall never surrender."

On June 4, 1940, Sir Winston's inspirational call to arms set in motion the events that led to the Allied defense of western civilization.

Lincoln: "Four score and seven years ago our fathers brought forth on this continent a new nation...."

In his 1863 Gettysburg Address, Lincoln invoked a "new birth of freedom" that would bring true liberty to all of the citizens of the United States.

Buy-Side Egomaniac: "I'm Busy Right Now."

In 2008, just about every buy-side trader in the world knows that those four words, when uttered in response to a well-intentioned phone call, will leave the salesman at the other end with no choice but to spend the rest of the day forwarding random axes. OK, trained monkeys could easily do that 3Go1Go work, but the Health Department won't allow monkeys on most trading floors. That's why there are hundreds of Duke and Villanova grads from Garden City executing that 4-button sequence for broker-dealers big and small.

It's not an exaggeration to say that HY salespersons spend 99+% of their Bloomberg time creating messages that will engender the I'm Busy Right Now response. So following the logic, it's almost surely the case that Bloomberg LP derives billions of dollars of its lofty enterprise value from three keys and one phrase.

Before Pat Riley gets here, I call "Trademark".

Saved The Union.

Saved Civilization.

Saved Time.

3Go1Go And Mondays Always Get Me Down

After a couple of wasted days at the crib, it's back to your 3Go1Go post. Nothing's changed---there are still hundreds of recipients ready to treat your every message as an extra-lethal mutant strain of the ebola virus.

What You See When You Send:



What They See When They Receive:

Speed Dial Issues

Face it---when it's performed by experienced experts operating at the highest levels of the game, 3Go1Go is a completely mindless activity. Unfortunately, some amateurs think "mindlessness" is the same as "auto-pilot".

That's a dangerous myth. Yes, 3Go1Go is a powerful weapon for today's bond pros, but it's a weapon that can blow up in your face when it's used carelessly, especially in conjunction with SpeedDial. Sending a customer's own axes back to him with an excessive mark-up or mark-down is never cool, just like a neutron bomb is never cool. A neutron bomb leaves the building standing but kills the people; an unedited SpeedDial leaves your Bloomberg standing but kills your relationships.

Here's your customer list before your SpeedDial screw-up:



Here's your customer list after:

Technique: Lesson 2

Once you've pressed "3" and then "Enter" (i.e., "GO", thus the name "3-GO, 1-GO"), you'll need to execute a "1" to continue the sequence. Here's a lefty "1":



Here's the righty version, executed via the numerical keypad.



The cool thing about this variation is that once you've pressed the "1", your finger will be in spitting distance of the "GO" key, which is where you'll complete the full maneuver. Nano-seconds later, 200 recipients will immediately delete your message before they even bother to open it. Do this a few hundred times a day, and you'll have sent out literally thousands of messages, and perhaps hundreds of thousands of axes, that literally nobody in the world gives a shit about!

Feeling spent? Time to catch the 5:20. This Bud's for you, pal.

Technique: Lesson 1

Here's the way it's done: this is a flawlessly executed "3", lefty. Until you've practiced a bit, you might want to use your right hand.

Note the picture of the kid, a constant reminder to keep pushing the keys until a customer responds or a pig flies.

4 Go?

Shouldn't the commutative law or the associative law or some middle school math bullshit apply to 3-Go, 1Go? Seems like you should just be able to do 4-Go and save a couple of keystrokes every time. Over the course of an average day, that might save you a couple hundred keystrokes. So you wouldn't have to go home exhausted every fucking night. And that would add up to more than 60,000 keystrokes per year! Say sayonara to Carpal Tunnel Syndrome!

Doesn't fuckin' work, though.

Hard Work.....

You spend your day doing 3-Go, 1-Go, and by five o'clock, you are spent. Firefighters, cops, marines...they've got the cushy jobs.

Try doin' 3-Go, 1-Go from 9-5, and then let's talk.