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Affluent Christian Investor | August 18, 2017

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How Normal Investors Can Use the Same Strategies as Hedge Funds

Courtesy of: Visual Capitalist

Courtesy of: Visual Capitalist

In a Warren Buffett note from 2006, he credits the famous value investor Benjamin Graham as the co-creator of the first-ever hedge fund in the mid-1920s.

“It involved a partnership structure, a percentage-of-profits compensation arrangement for Ben as general partner, a number of limited partners and a variety of long and short positions,” Buffett’s letter says.

That means that hedge funds have been around for nearly a century – and they have almost exclusively existed as a vehicle for institutions and wealthy, private investors.

Alternative Investments

The initial use of the hedge fund was to “hedge” specific investments against the general volatility of the market. Despite this namesake, today hedge funds use a number of strategies to target gains.

While retail investors rarely had access to these types of strategies, today it is possible to buy mutual funds or ETFs that try to emulate similar tactics. These alternative investment funds, or alt-investments, come in mainly two varieties:

Return Seekers: Designed to help boost performance by opening up new opportunities to investment, such as private equity or global infrastructure.

Risk Managers: Designed to help smooth performance when markets turn choppy. Strategies include long/short equity, merger arbitrage, managed futures, and other hedge fund strategies.

Today’s Market

The key here, in our opinion, is that these strategies may allow investors to diversify out of traditional markets such as stocks and bonds.

The timing for alternative investments could be good as well, as the start to 2016 was the worst in history for markets and the average investor already lost 3.1% in 2015.

Although funds specializing in alt-investments typically have significant diversification benefits, they also usually come with higher fees in comparison to more traditional offerings. Investors should weigh the cost-benefit accordingly.

Original graphic by: ProShares

 

Originally posted on Visual Capitalist.

Dr. Vernon L. Smith was awarded the Nobel Prize in Economic Sciences in 2002 for his groundbreaking work in experimental economics. Dr. Smith has joint appointments with the Argyros School of Business & Economics and the School of Law, and he is part of a team that will create and run the new Economic Science Institute at Chapman.

Dr. Smith has authored or co-authored more than 250 articles and books on capital theory, finance, natural resource economics and experimental economics. He serves or has served on the board of editors of the American Economic Review, The Cato Journal, Journal of Economic Behavior and Organization, the Journal of Risk and Uncertainty, Science, Economic Theory, Economic Design, Games and Economic Behavior, and the Journal of Economic Methodology. He is past president of the Public Choice Society, the Economic Science Association, the Western Economic Association and the Association for Private Enterprise Education. Previous faculty appointments include the University of Arizona, Purdue University, Brown University, the University of Massachusetts, and George Mason University, where he was a Professor of Economics and Law prior to joining the faculty at Chapman University. Dr. Smith has been a Ford Foundation Fellow, Fellow of the Center for Advanced Study in the Behavioral Sciences and a Sherman Fairchild Distinguished Scholar at the California Institute of Technology.

In 1991, the Cambridge University Press published Dr. Smith’s Papers in Experimental Economics, and in 2000, a second collection of more recent papers, Bargaining and Market Behavior. Cambridge published his Rationality in Economics: Constructivist and Ecological Forms in January 2008. Dr. Smith has received an honorary Doctor of Management degree from Purdue University, and is a Fellow of the Econometric Society, the American Association for the Advancement of Science, and the American Academy of Arts and Sciences.

Dr. Smith is a distinguished fellow of the American Economic Association, an Andersen Consulting Professor of the Year, and the 1995 Adam Smith Award recipient conferred by the Association for Private Enterprise Education. He was elected a member of the National Academy of Sciences in 1995, and received CalTech’s distinguished alumni award in 1996. He has served as a consultant on the privatization of electric power in Australia and New Zealand and participated in numerous private and public discussions of energy deregulation in the United States. In 1997 he served as a Blue Ribbon Panel Member, National Electric Reliability Council.

Dr. Smith completed his undergraduate degree in electrical engineering at the California Institute of Technology, his master’s degree in economics at the University of Kansas, and his Ph.D. in economics at Harvard University.

 

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