How To Build A Poor Man's Hedge Fund
By: What You Can't Do
Now that we’ve exhausted the purchasing power of the poor man’s hedge fund, here’s what you can’t do and why:
Distressed Debt
As of now, retail investors cannot get involved in the distressed debt market.
Here’s Why: When a company restructures in emerging from bankruptcy protection, equity investors lose out, and debt holders become the new equity holders. Hedge fund managers have found a way to get in on the action by calling themselves "distressed investors" and amassing large positions in this type of debt.
A 'large position' requires a multimillion-dollar investment in the company's debt, and time for the legal process to unfold. Given that the complex process demands multi-disciplinary expertise, the distressed debt market remains dominated by large hedge funds and private equity players.
High Speed Trading?
The Poor Man’s Hedge Fund cannot emulate quantitative, high-speed trading strategies because they require:
Computer whizzes to program complicated code for trading algorithms; cutting-edge computer hardware that can crunch the code and make microsecond trading decisions, and a very large pool of capital to take advantage of tiny price mismatches. Even fully equipped high-frequency shops estimate they make 0.1 cents per share on a trade. To put it another way, to make $100, you’d have to trade 100,000 shares.
“High frequency traders need to be physically located near an exchange to be able to trade in a nanosecond,” says Livian, Livian & Co.
Hasn’t anyone already tried this?
Yes. The IQ Hedge Multi Strategy Tracker ETFhas attempted to replicate an index of hedge funds by creating an ETF that invests in other ETFs. With meager returns, it is a one-stop shop solution for retail investors looking for hedge fund exposure without doing any of the legwork.
Considering the Index IQ management fee, you might want to think twice.
One of the rationales for using ETFs is the low fee. Index IQ is creating an ETF of ETFs. Thus when you buy this product, you pay all the fees on the underlying ETF (usually between 0.4-0.6 percent) and then on top of that you pay IndexIQ fees of more than 1 percent.
The hedge fund industry thrived for years because it managed to convince investors that its portfolio managers' skills are worth the 2-and-20-percent fee structure, say critics.
The few really talented ones justify their fee by investing in markets out of the reach of retail investors, with large pools of capital and cutting edge technology.
The rest? “Most hedge funds should be out of business,” says Livian.
