So, what stocks are you buying today?
June 18, 2021 by The Q.ai Team
The educational portion of this newsletter focuses on hedge funds.
Forget about markets this weekend – Solstice is finally here.
In 3:40 seconds, you will learn:
- 5 headlines that pretty much sum up the week
- Why you can’t always trust the price of meme stocks
- What a hedge fund really is
- Our rec of the week
Five headlines that sum up the week
1. The Dow drops 400 points in a single day
Source: Google Finance
The Dow is currently on pace for its worse week since January with week-to-date losses sitting at 2.7%. This is likely due to Wednesday’s Federal Reserve meeting, which resulted in an earlier forecast for interest hikes. The losses are widespread across indices, but it has proportionally affected the Dow the most. At this time, the S&P 500 fell 1.3% while the Nasdaq dropped 0.3% for the week. Specific sectors, such as energy and financials, have shown the biggest decline with Bank of America and JPMorgan Chase falling 2.1% and 1.9%, respectively.
2. Facebook Ads is already feeling the pain of Apple’s commitment to privacy
3. The Federal Reserve voted to leave interest rates alone
The Federal Reserve isn’t going to raise interest rates – possibly not for the another year. At this time, officials are suggesting that we will see a hike in rates as soon as 2023. Last March, officials claimed that interest rates would remain unchanged until 2024. This sent a ripple of unease to cautious investors, especially with the inflation expectation increasing by a whole percent since March. Powell admits that the Fed’s dual employment and inflation goals are pacing much more quickly than anticipated. This has led to the Fed seeing GDP growth reaching 7% (up from 6.5%) in 2021. Unemployment projections are still 4.5%.
4. PwC plans to increase headcount by 100,000 to support ESG initiatives
PwC announced on Tuesday that it would invest $12 billion over five years to create 100,000 new jobs with a focus on environmental, social and governance. It plans to develop a global strategy that aims to help its clients address climate and diversity reporting as well as artificial intelligence. PwC Chairman Bob Moritz shares that “of the 100,000 people PwC will hire, about 25,000 to 30,000 will be in the United States, and 10,000 of those will be from Black and LatinX communities.” Companies and investors are starting to fully lean on the value of ESG. Not only do asset managers weigh investment decisions based on ESG factors alone, U.S. companies are beginning to expect regulatory oversight of their environmental disclosures, board diversity and workforce.
5. Microsoft merges Chairman and CEO role
Satya Nadella, Microsoft’s current CEO, is now also the Chairman of the board. Since Nadella joined as CEO seven years ago, Microsoft’s stock has risen by 600%. He was responsible for several major acquisitions, including LinkedIn, Github and Zenimax. Merging the CEO and Chairman role is not the norm for the majority of S&P 500 companies – about 90% keep the roles separate. Despite its many challenges, Microsoft managed to increase its revenue by 14% in 2020, with most of the credit going to Nadella’s leadership throughout the pandemic.
ICYMI: Meme stocks may not be all that they seem
Meme stocks have been some of the most popular – albeit volatile – and heavily shorted shares on any given day. They are also traded differently than the average stock you’d buy and sell from a public exchange.
The majority of retail orders bypass exchanges due to the payment for order flow, which is an arrangement in which retail brokerages sell their customers’ marketable orders to wholesale brokers. While this lowers costs for traders, it distorts the true price of each share since the share price formation typically occurs within public exchanges.
And since over 50% of the market is now taking place off-market, knowing what the true supply and demand is of a stock’s share price is less clear.
To put things into context, retail trading’s commission-free structure has resulted in a surge of retail investing. Before the pandemic, individual traders were responsible for around 20% of market volume. Since the pandemic, the number has increased to 35%. With meme stocks in particular, that number has grown to 70%.
Source: Four Week MBA
The practice of payment order flow has been considered highly controversial. According to Gary Gensler, the chair of the U.S. Securities and Exchange Commission, the SEC plans to examine whether off-exchange trading distorts the price discovery mechanism for stock. If this review proves that is the case, regulation could be introduced, altering how we trade meme stocks forever.
What a hedge fund really is
- Hedge funds are private, pooled investments set up by a professional manager or registered investment advisor to invest in other securities, assets, or funds
- Hedge funds are usually only available to accredited investors due to their high risk and complex investment strategies
- These LLCs or limited partnerships are classified according to the underlying investment style, such as taking simultaneous long/short positions, investing based on events such as mergers or bankruptcies, or analyzing and investing in macroeconomic trends
- A hedge fund manager may take fees as high as 1-2% on all assets under management and 20% of all profits paid to investors above the hurdle rate
What is a hedge fund?
A hedge fund is a private, pooled investment arrangement set up by a professional fund manager or registered investment advisor. Unlike stocks or bonds, a hedge fund isn’t a specific type of investment. Rather, it’s a set of funds contributed from pre-qualified investors used to invest in other securities.
Originally, when hedge funds were created in 1949, they were designed to hold both long and short stocks to hedge against risk – hence the name. This ensured that participating investors made money regardless of the market’s movements. Since 1949, the inner workings have changed quite a bit, but the name has stuck around.
Source: Napkin Finance
What are the types of investments and fees?
Hedge funds are run by managers tasked with raising and investing funds according to their promised strategy. For instance, hedge funds may invest solely or in part in:
- Long or short stocks
- Junk bonds
- Real estate
- Private businesses
- Specialized assets such as music rights or patents
- And even other hedge funds
Hedge fund managers receive compensation based on the arrangements of the funds’ operating agreements.
One standard compensation plan is known as the “2 and 20,” where fund managers receive 2% net assets per year regardless of performance, plus 20% of profits above a predetermined price.
However, this fee structure has come under fire as hedge funds have faltered in recent years. As such, some hedge funds use a compensation structure based on pure profits.
Funds may also set a hurdle, or the minimum profit it must generate before managers can charge fees.
Who can invest in hedge funds?
Source: The Balance
Due to the risky nature and reduced regulatory oversight of hedge funds, hedge fund participants are limited to accredited investors. These are persons or entities who meet specific criterion according to the SEC.
Accredited persons must meet one of these criteria:
- Annual personal income of $200,000 or more for two consecutive years before making the investment
- Combined annual spousal joint income of $300,000 or more for two consecutive years before making the investment
- Personal or spousal joint net worth of $1 million or more excluding primary residence
Accredited entities must meet one of these criteria:
- A trust fund or benefit plan worth $5 million or more not formed specifically to make the investment and run by a “sophisticated” investor
- Any entity in which all investors are individually accredited
Other qualified investors include:
- An executive, partner, director, or other person tied to hedge fund
- Investment advisors
- Limited liability companies with more than $5 million in assets not formed specifically to make the investment
- Rural business investment companies
Note: a “sophisticated investor” is one with sufficient knowledge and experience to make informed decisions about potential investment risks.
Main types of hedge funds
Oftentimes, hedge funds are structured to take advantage of specific market opportunities. And as each uses its own strategy, hedge funds are classified according to investment style, leading to significant risk and investment diversity.
Some common strategies include:
- Long/Short Equity: The original hedge fund strategy, where a fund takes long positions in suspected winners to finance short positions in suspected losers
- Market Neutral: Comes with lower risk and lower expected returns than a traditional long/short strategy
- Event-Driven: Attempt to exploit pricing inefficiencies that surround corporate events, such as mergers, acquisitions, bankruptcies, and earnings calls
- Fixed-Income: Wherein a fund seeks returns on risk-free government bonds, such as by making leveraged bets on how a yield curve will change.
- Global Macro: Analyzes how macroeconomic trends will affect currencies, commodities, equities, or interest rates, and then taking long or short positions according to their views
The bottom line
Should you invest in a hedge fund? For many investors, this question is moot thanks to accreditation requirements. But even for those who qualify, hedge funds require significant capital and take outsize risks compared to more tightly regulated funds such as mutual funds or exchange traded funds. (Not to mention the massive fees incurred on hedge fund profits.)
As such, most investors may fare better investing in more traditional and accessible vehicles such as mutual funds, bonds, stocks, and ETFs. Alternatively, Q.ai offers a variety of investment kits, all of which can hedge against risk. The best part is that you don’t need hundreds of thousands in capital – just a minimum deposit of $100 to open an account.
Read the full “Investing 101” resource on hedge funds
If you haven’t used Reddit yet, are you really an investor? Reddit, aka the front page of the internet, is a cutting-edge way to lose hours of your day reading up on useless yet fascinating content. As an investor, there are dozens of subreddits dedicated to the different facets of investing. If you’re not interested in the YOLO mentality that r/wallstreetbets is known for, here are some other options.