Alternative Asset

  

When you think of investing, a few things usually come to mind: stocks, bonds and, at times, your mattress. But a wide universe of potential investments exists. Tons of ways to lose your money out there. The more unusual investment types are generally categorized as alternative assets.

Some of these fall into the general Wall Street sphere (the round kind), though they remain exotic for run-of-the-mill investors. Think: hedge funds, art work, rare coins, private equity, venture capital funds and/or just fancy bundles of derivatives. Other types of alternative assets might seem more like hobbies than investments. We're thinking of things like collecting rare wine or ancient Chinese erotic thimbles.

The issue with alternative assets is that they often require some specialized knowledge, a minimum amount of wealth and income, and a minimum standard of demonstrated financial expertise. They can be Century Investments (the kind that can go down 100% so the thought is that the less sophisticated investors who can't afford to lose everything should be made aware or protected from this peril.) Also, the markets tend to be far less liquid, meaning that it often takes a long time to get back your cash after you've bought all those sexy thimbles.

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Finance: What is a hedge fund?41 Views

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finance a la shmoop. how does a hedge fund work? so you've probably heard a lot

00:08

about the huge fees that hedge funds charge for the privilege of managing [woman looks shocked as hedge fund is advertised]

00:12

your money. that hedge funds are only investing vehicles for the wealthy and

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how mathy their employees are. but the actual workings of a hedge fund are a

00:23

lot like driving down a road in wartime. there are hills and there are valleys

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your car will Traverse wanting it to speed up and slow down but as long as

00:32

you continue to drive 37 miles an hour the enemy radar can't detect you so you

00:38

drive theoretically, safely down the road. alright so how does this translate to

00:42

financial investments in a hedge fund well essentially every investment made

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on an entity going up in value is usually offset by making a bet on a

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different entity going down in value. that's called hedging got it? the economy

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is coming out of the doldrums and you believe the entire stock market is gonna

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recover but you believe the worst companies which have been down some 90% [chart showing decline]

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in this bad bear market environment will actually do better over the next period

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of time than high quality companies like Coca Cola which didn't decline as much.

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that is yes Coca Cola stock will improve and you think it has Headroom to run

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upwards some 30% in the next year and a half but you believe crap burgers

01:30

dot-com which went from $100 a share at its peak to only $2 today could

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quadruple to 8 bucks in value over that same 18 months. like you get a much

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better percentage return on crap burgers than you do on coke. so as a hedge fund

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manager one quote easy unquote trade that you'll make is too short coca-cola

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betting essentially that it will go down, and then putting the same amount of

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money to being long crap burger com betting essentially that it'll go up. in

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essence the bet that you are making is that crap burger will go up a lot more [Coca-Cola and crap burger stocks in two separate baskets]

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than coca-cola will go up but if the overall market goes down

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well you'll be hedged in that you're short Coca Cola position will cushion

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the blow of crap burgers further demise and it's likely you're looking at crap

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burgers balance sheet and thinking well they have $2 a share in cash and no debt

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how much lower can they go .got it? hedge funds use stock options

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aggressively to manage risk in their portfolios the promise hedge funds make

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to investors is that their performance will be up and/or good whether the

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market goes up down or stay sideways. so another common hedge trade involves the

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use of put options on the market to protect the long trades the fund is

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making. specifically a hedge fund might find 3 S&P 500 stocks it really likes [ put option explained]

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and believes that they will be up significantly over the next two to three

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quarters earnings reports. but it's also nervous about nukes in North Korea in

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order to protect against a bomb going off and the whole market going down and

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ruining its investment performance, and yes there are bigger things to worry

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about then but that doesn't matter to hedge funds not their job. the hedge fund

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goes long the three stocks it likes but it buys put options on the market

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betting with those options that the market itself will go down. it's

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essentially playing both sides of the fiddle so that hopefully it wins in any

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set of circumstances. and yeah it's a lot more complicated than that in practice

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we're just given the idea here. in the case of a put option the market might be

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trading at ten thousand and a put option might have a strike price of nine

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thousand such that if the market declines below nine thousand the put [strike price illustrated]

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option goes quote in the money unquote and pays the investor handsomely for

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making the bet that the market would go from ten thousand and well somewhere

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below nine thousand. if that happened the three long stock bets that the hedge

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fund made would go down but their decline would be hopefully more than

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offset by the gains from the put options the hedge fund bought that were

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portfolio life insurance in the case the market puked. and if that happens well

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all you can really do is offer the market a breath mint and a moist

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towelette and then be sure to collect your fee. [person representing stock market offered towelette]

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