Ep 1: Are Hedge Funds an Impenetrable Exclusive Circle

Welcome to the show. Hello, TenX, welcome to Finding your Hedge. Thanks for joining me today. So the question is, you know, where do you see hedge funds in the great scheme of finance? Okay, so when I say that to add a bit of context, I mean, we are comparing like other investment companies, like private equity, ETF houses, family offices. Where do you see hedge funds?

TenX: Okay, if I may introduce one point, which will help to explain the rest of the structures, right? In investments in general, there’s this thing called risk-adjusted returns. 

So if let’s say you wanted to get, say, 10% annually, right, and across a period of three years, would you prefer something that is very volatile? That fluctuates a lot? That means in the first year, let’s say you’re up 5%, second year you’re up 15%. So by the second year annually, 10% on average. And then on the last year, just flat. 

Versus another scenario where perhaps you’re down 20%, you’re up 40%. And then for the last bit it’s like 40, 20 — divide by 3 — 60. So the last bit will be about 10%, I think. Then on average, annually is still doing about 10%. 

Okay. So risk-adjusted returns. Hedge funds are there originally to try and get superior returns, which is in more scenario A. You don’t want so much fluctuation and it’s more in the positive and they try to do that by hedging, basically.

So before, let’s say, the year 2000 and things like that, hedge funds originally were created because they were hedging. So that’s where the term hedge funds called. They go long, let’s say a lot of stocks, let’s say about a hundred stocks, they long about 60 of them, right. And then the other 40, they find that it’s not so good, right. They short. 

So that’s a way to hedge the market. And from there, they get the excess cash they get from shorting these stocks to buy even more. So they can even go to the ratio of 130-30. They short 30 stocks, but they long 130, out of their total pool of capital. However, the model hasn’t worked out so well, because it’s difficult to find the best companies. It’s also difficult to find the worst companies, right. And everyone else is participating in the market. So what you get for the risk-adjusted returns for hedge funds aren’t as good as compared to the market. The market being, let’s say like an index, which is you just buy S&P 500, right.

Every single year, annually you can get maybe 7-8%. Versus you put into hedge funds, and then it fluctuates. One day you’re up 5%, another day you’re down 20%, right? Yeah. So sometimes it will be better to put into other kinds of vehicles for investments. And that’s where the other structures come in.

And it’s also to expose yourself to different kinds of opportunities as well as risk. So let’s look at private equity, PE funds, right.

Sato Shi: Sure. 

TenX: So private equity funds don’t really have these kinds of fluctuations because they have a kind of control over the valuation of a company. Okay, what PE firms do is that they find , let’s say, companies to add to their portfolio, which they try to maybe improve their operations, right, by lowering the costs or increasing the revenue based on their own network and things like that. And usually their play is to borrow lots of money with the portfolio company, and then they use their cash to make the changes that’s required. So it’s very active, right, in the actual management of the company, they actually place the partners inside.

Sato Shi: Ah, it’s part of the board, am I right?

TenX: It’s part of the board. They even place the people that they know personally, that can turn around the company, for example.  And what happens is that the valuation of the portfolio company increases and then maybe about five, six years later, they sell it off to another company for profit . 

Sato Shi: Like an exit, am I right? 

TenX: Like an exit, right. Right, right. And so what you get is it’s actually quite a smooth chart up if you talk about returns of the portfolio company, because they’re in control of the valuation, right? If it’s a turnaround then every year it’s increasing its value by say 10%. And finally they say like, okay, it has to reach like 15 times. And then it’s time to sell and they don’t want to operate anymore, then they sell it to someone else who is willing to buy the company. 

Sato Shi: I see. So would you say this strategy is like growth at all costs, you know, no matter what you must grow every year, if not you’re not doing it right? 

TenX: So PE firms tend to be aggressive…

Sato Shi: Hyper growth? You know the… 

TenX: Hyper-growth would be more of the startups angle. So private equity also there is a branch, like if you are familiar with venture capital. So venture capital, but the risk tolerance is super high, right. So it’s just they throw in the money to perhaps get a moonshot idea that finds product market fit, and then you get a hundred times. 

Sato Shi: Okay, yeah. I’m sure it works, right? [Laughs]

TenX: So out of a thousand, right? If 10 of them work out, you’ve probably made money because it saves you from the rest of the 90 that lost money. Okay, I say that because the startup success rate is low. 

Sato Shi: Yeah. I mean, it stands up on itself. It’s not like a TenX thesis. It is what it is. 

TenX: It’s not easy, it’s really not easy. 

So it’s really a moonshot idea. You’re trying to do things differently in a market that may not understand your product so well , whereas the founders are also new and things like that. 

So there’s a lot of money that’s being put into these moonshot ideas because of those kinds of returns and for risk-adjusted returns-wise, well the valuation can be controlled as well, right? If the startup is doing well. Yeah, but I mean, most of the time, they… it’s hard to say, it’s really hard to say. 

Sato Shi: Oh, so would you classify VCs as part of the PE? Are they similar, or dissimilar? Or will you put them into a category of their own? 

TenX: Yeah, so they are in the private markets. That’s why it’s called private equity. 

Sato Shi: Okay. So VC is more like it’s a subset. 

TenX: It’s like a subset of investment funds operating in the private markets. Whereas for hedge funds, more often than not, you’ll find them operating in the public markets. So like stocks that’s listed and stuff like. Private equity markets, venture capital, you won’t find them dealing much with the public markets. More of unlisted stocks, unlisted stuff. Yeah. 

Sato Shi: But there is some component that are listed. Would you say that? 

TenX: Sure, sure, sure. So nothing’s stopping them if they have the proper license. Yeah. 

Sato Shi: Oh, you need a license to deal with unlisted?

TenX: Listed or unlisted. It’s more of getting the license to take people’s money to invest it.

So that’s where the investors come in and then you’ve got to show them like, what kind of risks they are dealing with. You have a prospectus, right. You’re telling them like, what are the kind of things that we will be involved in? Yeah. So these levels will have different licenses based off where you operate your fund.

Sato Shi: Sure. Then would you like to just share a bit about ETF houses and family offices? 

TenX: Sure. So for ETF houses they are mostly companies that already have certain products listed in the public market space. So ETF houses such as perhaps like Vanguard, Black Rock, you’ve heard of their ETFs, right? For S&P 500.

So the most common case for them is that they are trying to replicate the index. So S&P 500 is an index. 500 biggest companies in the US by market cap, right. But you can’t outright trade them. You can’t outright trade 500 companies. It’s going to be very costly, right? So they deal with that by replicating  the index, through an ETF. So they try to match that and they offer these products to the wider public. So your retail investors. 

You can also have hedge funds investing in these. It’s not a problem, right. But this is what ETFs actually do. So they are not so much about investing per se. But they do have a role to play in all this because they also participate in the buying of shares for certain companies that’s listed under their products as a constituent.

Sato Shi: Yeah. To elaborate on that point about, you know, ETF houses buying in the index. Would you say that, you know, it’s a sure win because of the way how ETFs works? Based on my understanding about, you know, let’s say a Vanguard ETF following the S&P 500 index. I mean, you know, if you don’t perform you’re out of the index and they get someone who’s performing to actually come in to take your spot.

So the 500 list is relatively dynamic. So you know, if I could just reference the great Warren Buffet, he was saying that, you know, if you are just a retail investor and you don’t know much about the market, I think you can just buy the SMP 500 and, you know, just wait and let it compound.

Do you agree with what is being said about ETFs? Like it’s a sure win?

TenX: So when Mr. Buffet, who mentioned that line, I think he was comparing also against to hedge funds. Yeah, so he did make a point and a challenge actually. So how’s the average hedge fund performing against the S&P 500, for example. Net-net, actually the market outperforms hedge funds. It’s not easy to actually make money from a hedge fund investment. Yeah. So for him is that if you’re retail, you don’t really want to spend so much time on researching companies, just buy the index, you know, just buy a ETF or something. 

Sato Shi: But Berkshire Hathaway, which is Warren’s company, for our listeners over there, what kind of company would you classify them? I know they’re an investment  company, but would you say they are a hedge fund by themself? 

TenX: They operate both on public and private markets. And they have other kind of partnerships together with them that do investments on behalf for them. But overall it’s an investment company. They invest in a lot of businesses that have very high cashflow because that’s what Mr. Buffett likes. And overall that increases the value of Berkshire Hathaway, right. Because each of the companies is producing cash in very different ways. So the company value just keeps increasing and increasing. 

Sato Shi: Do you feel that Mr. Warren, Mr. Buffet, was he coming from a good place when he, you know, shared that piece of advice?

TenX: Oh, for him, I think he really wanted people more to participate in ETFs rather than  hedge funds [laughs].  

Sato Shi: Do you know why, you know, what was his agenda? Because he probably had a… he’s a smart guy, am I right to say that? 

TenX: So there are performance fees involved, right. And he did mention that because hedge funds, they take this thing called 2 and 20. 2% management fee and 2% of the profits that they do make.

The thing is, well, if you’re putting in money with a hedge fund, right. And then it doesn’t make money, you still pay them the 2% of whatever you invested with them. And for him, I think his thinking was that that’s a waste of money. You are better served putting it into a index fund, which you can invest in yourself. 

Sato Shi: So I think he was doing a bit of a public education, he is being benevolent,  you know, he’s coming from a good place, am I right to say that? I say, why are you wasting that 2% when you can just buy into you know an ETF that replicates the index. 

TenX: And overall because there’s a lot of people out there that starts hedge funds claiming that they can beat the market, but most don’t.

Sato Shi: Okay. Can you just share very briefly about family offices? 

TenX: So family offices have the benefit of doing all kinds of investments. They don’t need to take in outsider money because it’s just their money. So think of really wealthy families, right. And they just want to have a office to actually manage the investments on behalf of them.

So they employ financial professionals to do the same thing that hedge funds do. Private equity, the same thing. But with their own money, I see. And family offices are more concerned with the affairs of the family, right. So there’s other stuff like managing the finances of, let’s say, the daughters and the son.

Are they spending  too much? How much should we allocate into their, like, fund for school? Yeah. Person bought a car, like, too expensive, okay, let’s like… so it’s more like the daily operations kind of thing, yeah. But they have a, they usually have some kind of investment arm. And the professionals which will look out for investments to grow the wealth of the family office.

Sato Shi: Yeah. Yeah. And this is why, ladies and gentlemen, the rich become richer, because of family offices, am I right, isn’t it?

TenX: Ah, no, no, no. It’s, it’s more of, okay… you can say, access and networks, the same way where people are able to build businesses, right. I think it’s mostly also through their networks,  the people that you know, and skillsets.

So with their own networks, they’re able to find investments that perhaps the hedge funds don’t know , private equity also may not know because of their personal contacts. And maybe sometimes family offices also will want to invest in their own businesses. 

Sato Shi: You know, talking about hedge funds. Do you feel that they are impersonal? Is there some like financial conspiracy in the background or is it, you know, run by humans or is it all algorithms? 

TenX: So it depends on the, again, the trade frequency and the spectrum of where these funds operate. There are a lot of investment firms, very long-term kind of horizon firms.

There are also a lot of short-term trading firms, right. Just like speculating within the price going up or down in five minutes. There’s also like on the extreme end, high-frequency traders. They also operate as hedge funds. Yeah. So that operates in like the millisecond space. 

Sato Shi: Sure. And there’s no human intervention because it’s too quick, right. Am I right to say that? It’s all run by algorithms, robots in a sense. 

TenX: Yeah. 

Sato Shi: But what you’re trying to say is that there are different  types of training strategies require different… depends on the degree of the human intervention. Okay, but based on your experience, during that one year, you know, in the hedge fund firm, I mean, what would you say the proportion is like? Is it like you know, humans 20%, algos 80%, or…? 

TenX: In my first year it was more long-term, right. So human wise, it was 90%. And 10% algos. And in the second year it was 80% algos and then 20% human. 

Sato Shi: Okay, so would you say, because, you know, algos are playing such an important role in our life? You know, we’re leveraging on technology. Do you see the human intervention part being phased out completely in the future?

TenX: Personally I don’t think so because the algorithms can only model what the original human thought of. And things change in the market. So if you search up, you can Google how quant firms were actually performing in this year during COVID, lots of them lost money. So none of them were actually expecting the kind of sell off in March. And this is like completely, completely, they had to completely rewrite their models basically. 

Some firms didn’t make money, con firms, I’m not saying all are bad. Yeah. But then again, you still need a human to go and look at a model, like, okay, what have you missed? And if that is true. That means every year changes. There’s probably going to be something new. You’re going to need a human to do and look at the model anyway. 

Sato Shi: I see. So you have that firm belief, definitely there must be a human somewhere to sort of like supervise the entire process. 

TenX: Right, right, okay, so you brought up machine learning, right?

At the end of the day, it’s some kind of bot which looks at data. So we can ask, where does the data come from? The data is being generated by other humans or maybe some of the bots, which brings the prices as well. Who moves these prices? 

Sato Shi: Humans. 

TenX: Right? So if it’s commodities, it’s demand and supply. It’s people buying and selling. The, demand for oil is because people want oil, right. If suddenly the preferences of people change or there’s another, touch wood, another COVID happens. And then all your airlines are grounded. All your cars are not moving. That’s unprecedented, right? Nor model can predict that.

No way. Like you, you never know when a new strain is coming out, right. Unless you have the data of all possible living organisms. It doesn’t work that way.  

Sato Shi: Okay, okay. You know, you have been through the entire hedge fund cycle. I mean, you made it there as a fresh grad, which is very impressive. I don’t think many people out there who actually have a chance to actually enter the hedge fund. 

Can you just share, do you feel that anyone else, other than yourself, with the opportunities you’ve been presented with, will anyone else be able to enter the sphere of hedge funds? Either as an investor or, you know, actually working like what you did in the past. 

TenX: Sure. I think as an investor, if you already know the funds that you want to invest in you have to have some kind of minimum capital amount. I think if you’re operating in Singapore, the amount for investors is, you have to meet the accredited investor amount, right. So you can freely participate, but of course at your own risk, 

Sato Shi: You know, as an investor, I just want to elaborate a bit on that point.

I mean, what would an ideal investor look like to a hedge fund? I mean, in terms of the millions you’re going to invest, is it like thousands. How is the entry, the barrier to entry to actually investing in a hedge fund? 

TenX: I think most hedge funds will be accepting of money. However, the type of person is what matters.

Okay. So there are certain mandates being set by the investors, right? Let’s say they’re more low risk. They’re more long-term looking. You only have to report to the investors perhaps once a quarter, right? That’s fine. That’s not putting so much stress on you. So for the investment manager, that’s perfect.

However, if you do get an investment mandate and investors that require reporting on a weekly basis or monthly basis, and they’re looking at your returns, “Hey, I’m not getting the kind of investment performance that I wanted.” And then you’re going to be under a lot of pressure. 

Sato Shi: Okay. So what you’re trying to say is the hedge funds, they pick their clients carefully that actually suit their… 

TenX: Yes.

Sato Shi: How does the profiling work? Do, you know, do we interview the clients? Because it seems like it’s not like a matter of just taking whoever can just give them money. 

TenX: I think it’s more like a casual talk, like how much do you understand about the financial  markets? Do you agree with the strategy that the fund is going to employ and are they willing to take on these kind of risks? They have to be patient most importantly. 

Sato Shi: I see. Coming from investment, is there an investment amount? Maybe you can just share, just a ballpark. 

TenX: I think the accredited investor amount varies by the bank that you have. Yeah. So I think you need to check with the bank. MAS has another set of requirements for .. that means facing the investment fund.

You can only take in people above I think $200,000. But in certain circumstances depending on how the funds are structured, you can go from maybe $20,000-100,000. So it really depends on two sides, right? So the first side is the investment fund, how are they structured. And according to that they have certain levels of licensing and based on their licensing, they can take in investors of X amount.

On the other side is that you have to become some kind of accredited investors to participate in the larger funds, for example, right. Or higher levels of risks. So that’s basically meaning like, okay, if you have higher amount capital, you kind of know what you’re doing. You know the risks involve, the MAS is willing to let you, okay, you take whatever risk you want. That’s why, that’s why you can go ahead with these kind of investments. So it’s more like a safety check. I mean… 

Sato Shi: So I want to move on to the second part of the question , you know, for all those a spiring listeners  out there that actually want to enter a hedge fund in the future.

Do you think that it is ever possible. You had done it before, but do you think somebody is able to replicate your success? 

TenX: Sure, sure,  sure. So, I think I was lucky. That’s a component that the fund manager was looking for some kind of … basically the projects that I was working on kind of match 90% of what he wanted to do.

But at the same time, the other funds that I did reach out to, right. They also have very specific needs according to their state of growth as a fund, right. Generally speaking, all of them are looking for alpha, right. For different kinds of ways to make more money. If you have that and you’re consistent with your returns. You can probably just pitch to them and see what they think about it. For the other fresh grads I know from, let’s say, like business school, usually they have some kind of thesis prepared. One long, one short. So wherever they interview for let’s say investment analyst positions.

Definitely it’s going to be something the interview will ask of them. Yeah. So what are your thoughts about the market? Which company are you looking at right now? Which is good to buy, which would you short. And always having this kind of information at the back of your head so that you’re ready to talk with any of the investment managers.

That’s if you are more of the business facing side, right. And something that’s long-term focus. Yeah. For short term focus, funds using algos and stuff, right definitely coding will help. 

Sato Shi: Which is what you have, am I right to say? You have a coding background? 

TenX: Yes. And being able to really understand how these systems are built and how you can make it fit inside the way the fund is actually managed. 

Sato Shi: I see. I think basically in a nutshell, depending on the path that you take probably in your studies, if, you know, if you have a data science background, like engineering background, like what you mentioned, probably would you say, like, it’s more towards the more short-term trading, the high-frequency trading aspect of the business?

Whereas if you are more of a long term thinker, you know, you can create a great thesis, you know, your ideas are sound and well-founded, then you can actually do long-term? Would you put it that way? 

TenX: Yes. 

Sato Shi: In a nutshell. So it really depends. 

TenX: Yeah. So having more of like the technical skills, I think it might be better suited to go towards the short-term trading kind of angle, but that doesn’t stop you from going on the long-term one either, right?

Yeah. So it’s all about … the third point is more like perspective, I think, because if you come from a different kind of industry, right. You bring in insight that’s not readily available by those already who’s been in there for a long time and they can’t really see how a third party sees it.

So point of view is interesting because that’s what they also ask in the interview. 

Sato Shi: So, there you have it guys. So I think TenX has been very generous in their sharing. So before I round this entire interview out, could you just quickly share, you know, what are the changes that you foresee happening in the hedge fund sector, because as you know, I think it’s very dynamic.

It’s very fast moving. Can you just share some of your personal thoughts on this? 

TenX: Sure. So the first one would be competition; so there’s a lot more firms popping up. So it’s becoming more difficult for hedge funds to actually attract investor money. Yeah. Because as more funds pop up also, they are also lowering their fees.

So I mentioned that 2 and 20, right? Maybe it’s 1 and 10 now. Yeah, it’s probably going down. 

Sato Shi: Okay, because I mean, it’s a race to the bottom because everyone, there’s a diversity of options, am I right to say that? So it’s a price war, basically. 

TenX: It’s a price war. 

Sato Shi: Okay. So 1 and 10 is reasonable. I think it’s quite expensive also. 

TenX: It depends on your AUM, right. So if your AUM is, let’s say, a billion. 1% is still kind of decent for one investment manager, okay. But if you’ve got a larger team, then your operation costs is going to be higher. Your fund size should be proportional to that. So  smaller funds that’s popping up, yes, but it’s mainly like one man, two man operations. 

Sato Shi: One-man, two-man, can make a hedge fund ah? 

TenX: Yeah. Why not? 

Sato Shi: Okay. Okay, I mean, setting up a hedge fund, I mean, I imagine an army of guys working in the background. No, one or two guy, you know, with a plan, you know, you could just set up shop, you know, register a company and you probably need to have the licenses, right, to run the hedge fund? 

TenX: Yes, so if you have some like, a capital markets license, that’s usually granted to the company, but for the person that’s running the hedge fund, if they’re having some financial background or some certifications to trade, right. To execute trade, to manage money. Yeah. That’s what is required. But one man, two men operations. This is not unheard of. 

Sato Shi: Oh, it’s not unheard of. But I mean, it sounds very difficult, like one or two men. I mean, you don’t have a track record. Unless you came from a previous hedge fund, so probably build your name up at a bigger hedge fund then you step up to actually go out on your own. Would you say that is the path? 

TenX: They could have come from other financial backgrounds also. They would maybe have a track record already. I think that’s the best case because without a track record, it’s going to be difficult to convince investors like, hey, I have an idea, I don’t know if it works or not, but would you like to park money with me? 

Sato Shi: I understand. Yeah, yeah. 

I think probably that could be, or that should be the path, you know, for almost virtually all the one or two man operations. If not, I mean, for a start, what you want to do is that you probably want to start up at a more established… 

TenX: Or you can start investing on your own. You have your own ideas, keep track of your history of trading, right. Or investments. And see how you perform after a few years. That’s your track record already, right? So if you want to work in a fund or you want to start your own, you have something to show. 

Sato Shi: I see. Okay, okay. So there we have it. TenX, thanks for sharing your wisdom and, you know, your experience and expertise with our listeners out there. I think it’s been very informative and very enlightening and I think it really answers the question, you know, whether, you know, are hedge funds exclusive, impenetrable? I don’t think so. I think you broke it down very well for our listeners out there. And I just want to thank you for taking the time to join us today. 

TenX: Sure. Thanks for having me.

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