In 1949, Alfred Winslow Jones devised and implemented an investment strategy that would forever brand him as "the father of the hedge fund industry." While working for Fortune Magazine and investigating financial strategies, Jones decided to launch his own fund and raised a total of $100,000, $40,000 of which was his own money.
Jones employed two strategies still used heavily by hedge fund managers today: Leverage and short-selling. To avoid requirements set in place by the Investment Act of 1940, Jones limited the number of investors to 99 and set up the fund as a limited partnership.
Even though Jones garnered sizable returns in his first few years heading the fund, his strategy did not come into the mainstream until the late 60’s. When George Soros and Warren Buffet adopted Jones’ strategy and launched their own funds, hedge funds were suddenly being sought after by an elite group of investors.
What caught the attention of the investors was how these hedge funds had little correlation to the market. They were "hedged" against any downtown or slump in the economy. While the S & P was lagging, Jones’ investors continued to make money on a yearly basis. He decided to charge his clients a 20% performance fee, still used today by hedge fund managers. However, while most managers today also charge a management fee (usually 1-2%), Jones did not charge his investors anything unless the fund made a profit.
Hedge funds still enjoy limited regulation and are not required to make periodic reports with the SEC under the Securities and Exchange Act of 1934. Because of this, hedge funds have much more limited transparency than do mutual funds. While there have been recent attempts by the SEC to tighten up hedge fund regulation, they still enjoy the freedom and secrecy that other investment vehicles do not.
The SEC warns, "You should also be aware that, while the SEC may conduct examinations of any hedge fund manager that is registered as an investment adviser under the Investment Advisers Act, the SEC and other securities regulators generally have limited ability to check routinely on hedge fund activities."
The one thing they do have control over, however, is who may invest in these hedge funds. The SEC mandates that only accredited investors or qualified clients may participate in hedge funds, due to the higher risk involved. However, the typical hedge fund investor is thought to be well educated when it comes to funds, and risks are usually communicated by the hedge fund manager.
In addition, in order to keep hedge funds "private" and in compliance with the Securities Act of 1933, soliciting or marketing is strictly limited. While hedge funds may have a website, only approved, qualified investors may access the site after their net worth is confirmed.
Today, there are over 10,000 hedge funds in existence with close to $3 trillion in assets under management. While some of them still use the staple strategy of leverage and short-selling, hedge funds today employ hundreds of different strategies, and not all all of them are "hedged," as Jones’ was. Still, his business model that successfully dodged U.S regulation and his innovative investment strategy were the basis for the hedge fund industry today.
Suppose that the market dropped 20% in one year (as it did in 2001 and again in 2002). You might have to spend the bulk of the next big move up in the market just getting back to even, instead of making money. But suppose we were able to walk away with a flat return...or just a small loss instead. Would you agree that we’d be in much better shape heading into the next move up in the market, if we could avoid “the big hit?”
Now, there used to be a time (throughout the 1980’s and 1990’s), that absorbing just a small loss in a year where the market drops 20% would be called “significant performance” compared to (or relative to) the rest of the market. This is because folks in the market were more interested in “relative returns” back then, not “absolute returns.”
The reason so many were interested in “relative” returns back then was because throughout the ‘80’s and ‘90’s, we were barreling down the highway in a secular bull market. Every pull back along the way was simply a terrific buying opportunity. You were dubbed a hero if the market dropped 25% in one year and you were able to lose only 10%.
Not so today!
We’re not interested in “relative” returns and neither should you. What we are interested in is absolute returns.
The methods we use (a blend of fundamental analysis and point and figure technical analysis) are not perfect every time. But they do an excellent job of telling us when supply overtakes demand. This is true whether or not we are looking at a particular mutual fund, an individual stock, a sector or the market as a whole. Whenever supply overtakes demand, lower prices are certain to follow. And we should take the steps needed to protect our retirement dollars at that time.
Look, losing money impacts your returns for many years, not just one year. That’s because if we have a year where we lose 20%, we’ll need to make 25% just to get back to where we began. It’s really important that we do our very best to avoid big losses in our account...whether that account is our regular brokerage account, or our 401k account, or some other retirement plan.
So what do you do to avoid big losses when the market is crashing?
In 401k and other retirement accounts, we have a “safety valve” option which, if used properly, allows us to sidestep much of the damage. It is often called the “stable value” fund or the “stable income” fund.
The stable fund is often a guaranteed insurance contract (or “GIC”) that will give you a safe place to park your money, out of the stock market. There are millions of people (yes, millions) who have all of their money in their retirement plans invested in the stable fund.
In 2005, many of the plans that we advised had stable funds that generated yields in the neighborhood of 3% to 4% for the year. Listen: if you stayed in the “stable fund” for all of 2005, you beat the entire Dow Jones Industrial Average and the Standard & Poor’s 500 index.
But this is really not the goal of the stable fund.
The “stable fund” is an investment that really should be looked at as a “parking place” or a temporary spot, to hold your funds while the market is going down, or on defense.
In secular bull markets, we’d have little use for the “stable fund,” since we’d want all of our funds invested all the time. But that is not the current environment we have in 2006.
When the market begins to drop, we’ll often recommend that a certain percent of your money go to the stable fund, instead of some other investment. This is because it’s better to just stay out of the game than to take a risk, when everything’s going to the dogs.
Sometimes we may recommend you have most of your money in the stable fund. It really depends on your age, your tolerance to handle the fluctuations of the market and where things are heading at that current time. If a new client comes to us when the market is falling, it may take as long as four to six months to get most of the money back into the market. It all depends on where the market is at when we begin.
The stable fund is an instrument we can use to generate decent returns in an otherwise bad market. Nobody’s perfect when it comes to investing, but making use of the stable fund is a useful tool to have inside of a retirement plan. It gives you more flexibility.
By the way, were you aware that close to 80% of all participants in 401k plans (and other retirement plans as well) make their investment choices on the day they join the plan...and then never change them again?
Since Social Security is a mess and pension plans are disappearing by the minute, managing the returns in your 401K has never been more important.
Thomas Mullooly, President of Mullooly Asset Management, works one on one with individuals so they can regain control of their investments. To learn how to stop making simple investing mistakes and to sign up for Tom's email alerts, visit http://www.mullooly.net, today! Or call Tom at 877.223.7300 to request to see for yourself, in writing, how to manage the risk in your 401k plan.
Article Source: ezinearticles.com|
|