this is a highly simplified (though sincere) explanation attempt for the sake of understanding the basics. readers' discretion requested
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What is an investment bank?
= it is the trading BROKER to banks, funds and sophisticated
hni clients. Gets COMMISSION to execute trades of its clients mostly DECIDED BY
CLIENTS. They don’t trade with their own funds (except for a very small
portion). Practically all they do is take orders like salesmen and punch in the
computers. 100% of the trade is done by algorithms.
Very few funds, banks etc hire them for their stock/investment
research these days as everyone has their own in-house research teams. Investment
bankers are endangered species. Investment bankers these days are living
hand-to-mouth lives.
So, if someone says he is an investment banker, it will
sound as “order clerk” to me (except for very few, which i will mention later)
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What is a hedge fund?
= (hedge fund is what i respect after knowing the definition
of an investment bank.) a hedge fund, simply put, is the “mutual fund” of
banks,funds and hni clients! Not only that, the main thing is that they put in
their money also to trade (this is one of the clauses). So much so that they
are bound to plough back 50% of their performance bonus back into trading (this
is also in the clauses). This gives funds etc confidence to “risk” their money with a
particular hedge fund.
Why is hedge fund so called?
Well simple....they take equal no of long and short
positions (by value) to give broad umbrella security to the fund god forbid
something really terrible happens! This is nothing but hedging. Any money they
make while fulfilling this hedging condition is by picking and choosing good
stocks for long and good stocks for short opportunities (highly simplified
explanation)
They charge
a) fund management fee (typically 1% of AUM asset under
management),
b) performance bonus (typically 20% of profits earned)
so a $1billion hedge fund will get $10million in management
fee and $40million in performance bonus assuming $200 million profits.
(commission for investment bankers is 0.25% by the way.......
not surprising for what they do)
a hedge fund client typically expects an annualised return of 20% with max volatility (running carried forward loss) of 15%, failing which he generally quits with his money in search of a better hedge fund, taking along, in the process, pride, reputation and track record of the hedge fund!
a hedge fund manager is more of a fundamental investor than a technical trader, though he is a quite skilled trader.
I was shocked to know that while fund management fee is
invoiced locally, tax is payable on this in the country, while the performance
bonus is invoiced at the out-of-country tax-haven office of hedge fund so that
taxes are minimised, if not avoided!!!
Since hedge funds are thriving and investment bankers are “starving”,
all good traders have left investment banks and either joined hedge funds or
doing their own trading! (difficult to retire once u have smelled the big
money)
by the way, every consistently successful trader is a mini hedge-fund manager (though managing, as of now, only one side of the hedge!)
