The Investment U e-Letter: Issue # 725
Wednesday, October 31, 2007 Hedge Fund Returns: Three Ways to Trade & Profit Like a Hedge Fund
by Louis Basenese, Advisory Panelist, Investment U; Associate Investment Director, The Oxford Club Editor's Note: Today, Oxford Club Associate Investment Director Louis Basenese shows you why we don't have to wait to join the ranks of the uber-rich to enjoy hedge fund returns. According to Louis, all you need is an ordinary brokerage account (with margin privileges) to trade and profit like a hedge fund. - Alexander Green, Chairman, Investment U Although much maligned recently, hedge funds still provide investors considerable benefits. Most notable - blockbuster returns with very little correlation to the stock market. For example, the C&O Investment Partnership Fund is up 44.19% through September, almost five times the return of the S&P 500. And it boasts a -0.53 correlation with the index. There's a catch of course… Before you can put a single dollar to work in a hedge fund, the SEC insists you have a net worth of at least $1.5 million. Even if you're among the 8.5% of Americans that qualify, entrance is not guaranteed. The best hedge funds accept new investors by invitation only. And the entrance fees tend to be steep. Take ESL Investments, for instance. To accept their invitation you need to pony up $25 million… and agree to leave it put for five years. Thankfully, you can overcome these seemingly impossible obstacles with an ordinary brokerage account. And in the process reap all the rewards, without most of the hassle and expense. Sounds too good to be true, I know. But let me explain four strategies you can use immediately to do exactly that. Three Ways To Enjoy Hedge Fund Returns When you distill hedge funds to their core, the key differentiation from typical investment strategies is a willingness to invest on both sides of the market (long and short). At the same time.
In fact, when Alfred Winslow Jones started the first hedge fund in 1949, that was his unique selling proposition - by playing both sides of the market he avoided market risk.
He bought as many stocks as he sold, so any market swings up or down would be a wash. The key determinant of profits then would hinge upon whether he had picked the right stocks.
This simple technique proved wildly successful. And that's when the whole law of "it pays more to sell advice than to actually follow it" kicked in. Hedge funds popped up everywhere, with managers charging 2% management fees and skimming 20% of profits off the top.
So, the first thing you can do to start trading like a hedge fund is simply embrace the power of trading both sides of the market. During early stages of a bull market, increase your long exposure. And when a bull market gets particularly long in the tooth (like now) start to increase your short exposure.
This simple technique will both reduce your risk and set you up to profit no matter which way the market heads next.
- 2. Monitor 13-D and 13-G Filings
Imagine playing poker and being able to see the competitions' best cards. Well, greater transparency on Wall Street provides exactly that advantage. Now, hedge funds that acquire 5% or more of a company must disclose it under SEC Rule 13D or 13G within 10 days.
Here's the thing - not only can you see their best cards, you can put them in your hand, too. All you have to do is monitor the daily filings at www.sec.gov… and piggyback on the trades.
Of course, you only want to follow the most successful hedge fund managers. My short list includes Steven Cohen (SAC Capital), Edward Lampert (ESL Investments), David Einhorn (Greenlight Capital), Carl Icahn (Icahn Partners LP), Kenneth Griffin (Citadel Investment Group) and James Simmons (Renaissance Technologies).
One more note, give priority to 13-D filings.
As opposed to passive hedge fund managers filing 13-Gs, those who file 13-Ds plan to play an active role in bringing about change at the particular company (by demanding a board seat or making public calls for a sale.) Hence the "activist investor" label often attached to such filings. In the end, this desire to agitate management often leads to much quicker changes… and profits.
- 3. Buy Individual Companies That Operate Like Hedge Funds
If the two strategies above seem like too much work, you can simply buy individual companies that operate like a hedge fund. Two such opportunities exist with Sears Holding (Nasdaq: SHLD) and Greenlight Capital Re (Nasdaq: GLRE).
Sears, of course, is run by Edward Lampert. The hedge fund he founded - ESL Investments, which returned an average of 30% per year since 1988 - owns a hefty 42.5% stake in the company.
Even more compelling, the board granted Mr. Lampert discretion over Sears' $4 billion war chest. I expect him to start using it and the cash-generating retail operations to fund strategic acquisitions, like his idol Warren Buffett started doing several decades ago at Berkshire Hathaway.
Greenlight Capital represents another hedge fund in a stock opportunity. It's a specialty reinsurance company founded by David Einhorn, a hedge fund manager with over $4 billion under management and a track record of delivering roughly 25% per year for the past decade.
Long story short, he manages Greenlight's insurance premiums just like he does his hedge fund assets. And although the company recently went public, given Einhorn's track record, it's reasonable to expect the profits and share prices will quickly climb. Stay Tuned… A Fourth Hedge Fund Strategy Is Coming Next Wednesday, I'll reveal my fourth and perhaps most profitable strategy for making hedge fund returns. I'll also include two stocks you can invest in right now… and a complete rundown on the benefits of putting these strategies to work in your personal account. Until then… good investing, Louis Basenese Today's Investment U Crib Sheet: - To follow Louis' stock picks - trade-by-trade - you can get them all here. You'll have immediate access to each of his current and future recommendations.
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