Binary Numbers

WEBVTT
Kind: captions
Language: en

00:00:00.750 --> 00:00:03.320
What I want to do in this
video is revisit some ideas

00:00:03.320 --> 00:00:05.630
that you've probably taken
for granted since the time

00:00:05.630 --> 00:00:08.010
that you were like
three or four years old.

00:00:08.010 --> 00:00:10.380
But hopefully, you'll kind
of view it in a new light,

00:00:10.380 --> 00:00:12.130
and it'll help inform
us when we think

00:00:12.130 --> 00:00:15.520
about other types
of number systems.

00:00:15.520 --> 00:00:17.920
So we have 10 digits
in our number system.

00:00:17.920 --> 00:00:19.170
So let me just start counting.

00:00:19.170 --> 00:00:21.610
So if I have nothing,
I use the symbol 0.

00:00:21.610 --> 00:00:23.730
Then if I have one object,
I use the symbol 1.

00:00:23.730 --> 00:00:25.110
Actually, let me draw this out.

00:00:25.110 --> 00:00:25.769
So nothing.

00:00:25.769 --> 00:00:27.810
And then if I have one
thing, I use the symbol 1.

00:00:27.810 --> 00:00:31.000
If I have two things,
I use the symbol 2.

00:00:31.000 --> 00:00:33.730
If I have three things,
I use the symbol 3.

00:00:33.730 --> 00:00:36.230
Let me scroll down a little
bit, make sure you can see that.

00:00:36.230 --> 00:00:40.760
If I have four things, I use
this symbol right over here.

00:00:40.760 --> 00:00:45.900
If I have five things,
I use this symbol.

00:00:45.900 --> 00:00:47.780
If I have six
things, I'll start--

00:00:47.780 --> 00:00:49.980
let's draw it like that--
if I have six things,

00:00:49.980 --> 00:00:51.670
I use that symbol.

00:00:51.670 --> 00:00:55.567
If I have seven things,
I use that symbol.

00:00:55.567 --> 00:00:57.650
I know this might be getting
a little bit tedious,

00:00:57.650 --> 00:00:58.920
but this all has a point.

00:00:58.920 --> 00:01:03.650
If I have eight things,
I use this symbol.

00:01:03.650 --> 00:01:09.940
And if I have nine
things, I use this symbol.

00:01:09.940 --> 00:01:17.570
And then if I have 10 things, so
1, 2, 3, 4, 5, 6, 7, 8, 9, 10.

00:01:17.570 --> 00:01:19.290
What symbol do I use?

00:01:19.290 --> 00:01:21.400
I've already used
up my 10 digits.

00:01:21.400 --> 00:01:24.090
We only have 10 digits
in a base 10 system.

00:01:24.090 --> 00:01:25.860
So we start reusing them.

00:01:25.860 --> 00:01:30.340
So what we do is we introduce
this idea of number places.

00:01:30.340 --> 00:01:34.250
You say that I have
1 ten and 0 ones.

00:01:34.250 --> 00:01:40.730
So you say you have 1
ten, and then 0 ones.

00:01:40.730 --> 00:01:44.600
We call this 1, we say
it's in the tens place.

00:01:44.600 --> 00:01:50.990
This is literally saying
1, this is saying 1 tens.

00:01:50.990 --> 00:01:54.597
This is 1 tens plus 0 ones.

00:01:54.597 --> 00:01:57.180
So that's what this is saying,
but we didn't have to reuse it.

00:01:57.180 --> 00:01:59.580
We could have had
maybe more symbols.

00:01:59.580 --> 00:02:01.880
Maybe this was a
symbol, or maybe we

00:02:01.880 --> 00:02:04.130
would have created a new
symbol, instead of, you know,

00:02:04.130 --> 00:02:05.740
all of these had
their own symbol.

00:02:05.740 --> 00:02:07.531
So instead of having
to reuse the old ones,

00:02:07.531 --> 00:02:11.816
maybe we could have made
the symbol star for 10.

00:02:11.816 --> 00:02:13.190
And then when you
go to 11, maybe

00:02:13.190 --> 00:02:14.814
would have had another
symbol for that.

00:02:14.814 --> 00:02:17.180
Let me go to 11 just
to hit the point home.

00:02:17.180 --> 00:02:22.950
So 2, 3, 4, 5, 6,
7, 8, 9, 10, 11.

00:02:22.950 --> 00:02:28.570
So 11 in our number system,
we say that this is 1 ten--

00:02:28.570 --> 00:02:34.210
let me write it this way-- and
then this is also, it's 1 ten

00:02:34.210 --> 00:02:35.035
and then 1 one.

00:02:37.770 --> 00:02:41.120
So it's 1 ten plus 1 one.

00:02:41.120 --> 00:02:43.490
I know this is kind of
strange to see it this way,

00:02:43.490 --> 00:02:46.200
but it represents this
number of objects.

00:02:46.200 --> 00:02:49.634
If we had a base 11, or I guess
we could say base 12 number

00:02:49.634 --> 00:02:51.300
system, maybe we would
have had a symbol

00:02:51.300 --> 00:02:53.330
for this instead of
reusing our old digits.

00:02:53.330 --> 00:02:56.009
Maybe a symbol could have
been something wacky.

00:02:56.009 --> 00:02:57.550
Maybe it would've
been a smiley face.

00:02:57.550 --> 00:02:58.970
Who knows what it
would have been?

00:02:58.970 --> 00:03:01.390
And I'll introduce
higher number base

00:03:01.390 --> 00:03:04.300
systems in kind of future
videos, where we see what,

00:03:04.300 --> 00:03:06.962
kind of, the symbols
that are actually used.

00:03:06.962 --> 00:03:08.420
But what I want to
do in this video

00:03:08.420 --> 00:03:10.460
is think about,
how would we count,

00:03:10.460 --> 00:03:14.190
or what symbols would we
use, if we had fewer digits?

00:03:14.190 --> 00:03:17.190
And in particular, how
would we count things

00:03:17.190 --> 00:03:19.020
if we only had two digits?

00:03:19.020 --> 00:03:21.654
If we only had 0 and 1.

00:03:21.654 --> 00:03:23.570
And that's essentially
what we're going to do,

00:03:23.570 --> 00:03:27.620
is think about how we would
represent numbers in base 2.

00:03:27.620 --> 00:03:31.060
Our traditional number system
is a base 10 number system.

00:03:31.060 --> 00:03:34.040
We have 10 digits, 0 through 9.

00:03:34.040 --> 00:03:36.560
How would we count in base 2?

00:03:36.560 --> 00:03:38.970
So if you have zero things,
you'd still probably say,

00:03:38.970 --> 00:03:41.910
hey, I have zero, I
can use the digit 0.

00:03:41.910 --> 00:03:43.780
If I have one thing,
I could still say,

00:03:43.780 --> 00:03:47.061
hey, I have one thing, because
we have the digits 0 and 1.

00:03:47.061 --> 00:03:48.060
So let me make it clear.

00:03:48.060 --> 00:03:55.850
The digits here, the digits
in base 2 can be 0 or 1.

00:03:55.850 --> 00:03:59.300
So if I have one thing, I
can still use the number 1.

00:03:59.300 --> 00:04:02.030
But now all of a sudden, I
have these two objects here,

00:04:02.030 --> 00:04:06.890
and I'm saying that I'm limited
to only these two digits

00:04:06.890 --> 00:04:07.520
over here.

00:04:07.520 --> 00:04:09.220
So how could I represent it?

00:04:09.220 --> 00:04:11.270
Well, instead of
having a tens place,

00:04:11.270 --> 00:04:13.440
I could create a twos place.

00:04:13.440 --> 00:04:15.980
And I know it might sound a
little bit counterintuitive,

00:04:15.980 --> 00:04:17.938
but I think you'll get
used to it a little bit.

00:04:17.938 --> 00:04:23.180
So over here in base 10, we
said we had 1 ten and 0 ones.

00:04:23.180 --> 00:04:30.450
So in base 2, why can't we say
that we have 1 two and 0 ones?

00:04:30.450 --> 00:04:32.200
Let me make that clear.

00:04:32.200 --> 00:04:40.434
So this right here is
saying 1 two and 0 ones.

00:04:40.434 --> 00:04:42.600
I want to make sure you
understand the analogy here.

00:04:42.600 --> 00:04:45.430
In base 10-- let me write
a larger number in base 10.

00:04:45.430 --> 00:04:49.960
So if I write the
number 256 in base 10.

00:04:49.960 --> 00:04:53.350
So this is base 10 over here.

00:04:53.350 --> 00:04:54.290
What is this saying?

00:04:54.290 --> 00:04:59.850
This is saying 2 hundreds,
so 2 times 100-- or maybe

00:04:59.850 --> 00:05:01.510
I should write down
the word, because I

00:05:01.510 --> 00:05:06.850
don't want to confuse the
symbols-- 2 hundreds plus 5

00:05:06.850 --> 00:05:09.440
times, or maybe I
should say, 2 hundreds

00:05:09.440 --> 00:05:19.902
plus 5 tens plus 6 ones.

00:05:19.902 --> 00:05:21.110
That's what I represent here.

00:05:21.110 --> 00:05:22.610
And the way we know
that, is that we

00:05:22.610 --> 00:05:24.780
know that if we go two
places to the left,

00:05:24.780 --> 00:05:28.580
this is the hundreds place.

00:05:28.580 --> 00:05:30.490
This is the tens place.

00:05:30.490 --> 00:05:31.930
And this is the ones place.

00:05:31.930 --> 00:05:33.520
And if you know
from your exponents,

00:05:33.520 --> 00:05:36.330
this is equal to 10 times 10.

00:05:36.330 --> 00:05:40.260
This right here is equal to
10 times itself only once.

00:05:40.260 --> 00:05:42.370
And this is equal
to 10 times itself,

00:05:42.370 --> 00:05:44.400
I guess you could
call it, zero times.

00:05:44.400 --> 00:05:48.090
Or if you know your exponents,
this is 10 to the second power.

00:05:48.090 --> 00:05:50.330
This is 10 to the
first power place.

00:05:50.330 --> 00:05:52.080
And this is 10 to
the 0-th power place.

00:05:52.080 --> 00:05:53.323
And if you added
another digit here,

00:05:53.323 --> 00:05:54.739
that would be the
thousands place,

00:05:54.739 --> 00:05:56.780
which would be 10
times 10 times 10.

00:05:56.780 --> 00:05:59.070
We're going to do the
exact same thing in base 2,

00:05:59.070 --> 00:06:01.750
but instead of using 10,
we're going to use 2.

00:06:01.750 --> 00:06:03.770
So now this is the twos place.

00:06:03.770 --> 00:06:05.540
This is the twos
place over here.

00:06:05.540 --> 00:06:07.070
This is the ones place.

00:06:07.070 --> 00:06:09.640
If we add more digits
let me make it clear.

00:06:09.640 --> 00:06:13.840
So in base 2, let me write
a number here in base 2.

00:06:13.840 --> 00:06:17.560
And remember, in base 2 I
can only use zeroes and ones.

00:06:17.560 --> 00:06:23.235
So in base 2 maybe I
have the number 1010.

00:06:23.235 --> 00:06:25.610
So when you think about it
this way, if this was base 10,

00:06:25.610 --> 00:06:28.070
you would call this the tens
place, the hundreds place,

00:06:28.070 --> 00:06:29.240
and the thousands place.

00:06:29.240 --> 00:06:31.020
But this is base 2 now.

00:06:31.020 --> 00:06:32.730
So let me be very clear.

00:06:32.730 --> 00:06:34.540
We are only using two digits.

00:06:34.540 --> 00:06:38.760
So in base 2, this right here,
this is still the ones place.

00:06:38.760 --> 00:06:41.040
Now this is going to
be the twos place.

00:06:41.040 --> 00:06:43.060
Remember in base 10
this was the tens place.

00:06:43.060 --> 00:06:45.170
Now this is the twos place.

00:06:45.170 --> 00:06:47.980
Now this would be, and you
could take a guess here,

00:06:47.980 --> 00:06:49.930
hundreds was 10 times 10.

00:06:49.930 --> 00:06:53.470
When we go two spaces
to the left in base 2,

00:06:53.470 --> 00:06:55.770
this should be the
2 times twos place,

00:06:55.770 --> 00:06:57.335
or this is the fours place.

00:07:00.110 --> 00:07:04.230
This over here is going
to be the eights place.

00:07:04.230 --> 00:07:05.770
So if you wanted
to kind of think

00:07:05.770 --> 00:07:14.660
about this in terms of base 2,
this is 1 eight plus 0 fours

00:07:14.660 --> 00:07:19.810
plus 1 twos plus 0 ones.

00:07:22.940 --> 00:07:26.680
So if you wanted to represent
this exact same number in base

00:07:26.680 --> 00:07:30.360
10, it's 1 eight plus 1 two.

00:07:30.360 --> 00:07:33.420
So in base 10 this would
be-- let me write it

00:07:33.420 --> 00:07:35.960
over here-- in
base 10, this would

00:07:35.960 --> 00:07:39.970
be an 8 plus a 2,
which is just a 10.

00:07:39.970 --> 00:07:42.581
So this is it in base 10.

00:07:42.581 --> 00:07:44.080
This is how you
would represent what

00:07:44.080 --> 00:07:47.580
we know as this many
things, as 10 things,

00:07:47.580 --> 00:07:49.920
this is how you would
represent it in base 2,

00:07:49.920 --> 00:07:53.700
this is how we know we would
represent it in base 10.

00:07:53.700 --> 00:07:56.760
Now let's continue here, just to
make sure we understand things.

00:07:56.760 --> 00:07:58.540
So, this many objects.

00:07:58.540 --> 00:08:02.130
Well, in base 2, we
have 1 if you just

00:08:02.130 --> 00:08:05.330
have two objects,
that's 1 two and 0 ones.

00:08:05.330 --> 00:08:08.870
Now, three objects would
be one 2 plus 1 ones.

00:08:08.870 --> 00:08:09.990
So let me do it over here.

00:08:09.990 --> 00:08:12.990
So this would be
1 two plus 1 one.

00:08:12.990 --> 00:08:18.670
So this is three
objects in base 2.

00:08:18.670 --> 00:08:20.120
Now when you go to this.

00:08:20.120 --> 00:08:25.870
So over here we have 1
four, 0 twos, and 0 ones.

00:08:25.870 --> 00:08:28.082
So now we're going to
go to the four place,

00:08:28.082 --> 00:08:30.040
because we've essentially
maxed out everything.

00:08:30.040 --> 00:08:32.375
If we increment more, we
have to go to one more place.

00:08:32.375 --> 00:08:34.000
Just like we did in
base 10, but now we

00:08:34.000 --> 00:08:36.730
could only use the
digits 0 and 1.

00:08:36.730 --> 00:08:41.650
So now we'll have 1
four, 0 twos, 0 ones.

00:08:41.650 --> 00:08:43.141
Now when we add one more.

00:08:43.141 --> 00:08:44.390
We're going to add one more 1.

00:08:44.390 --> 00:08:50.150
So now we have 1 four,
0 twos, and 1 one.

00:08:50.150 --> 00:08:53.540
And just to be clear,
this is this many things.

00:08:53.540 --> 00:08:56.010
This is this many
things in base 2,

00:08:56.010 --> 00:08:59.240
this is the four place,
1 four and 1 one.

00:08:59.240 --> 00:09:01.370
If you wanted to convert
this into base 10,

00:09:01.370 --> 00:09:08.690
you'd say, look, this is
1 four, 0 twos, and 1 one.

00:09:08.690 --> 00:09:10.910
So if you have a
four and a one, we

00:09:10.910 --> 00:09:14.050
would represent that with
the symbol 5 in base 10.

00:09:14.050 --> 00:09:16.930
We don't have that symbol
available to us in base 2.

00:09:16.930 --> 00:09:18.100
Let's go to this.

00:09:18.100 --> 00:09:19.990
So now we're going to
increment one more.

00:09:19.990 --> 00:09:21.656
So, how can we represent
that in base 2?

00:09:21.656 --> 00:09:23.770
This is definitely, we're
going to have 1 four.

00:09:23.770 --> 00:09:26.960
And then we're
going to have 1 two.

00:09:26.960 --> 00:09:29.590
And then we're going
to have 0 ones.

00:09:29.590 --> 00:09:31.230
And if you keep--
it's kind of fun

00:09:31.230 --> 00:09:32.680
to practice counting in base 2.

00:09:32.680 --> 00:09:34.350
You'll start to
get the hang of it.

00:09:34.350 --> 00:09:38.699
So here we have to add 1 one
to this, so we get 1, 1, 1.

00:09:38.699 --> 00:09:40.240
And now when we get
to eight, there's

00:09:40.240 --> 00:09:42.020
no way to kind of
increment any of these

00:09:42.020 --> 00:09:44.110
any higher, so we have
to get a new place.

00:09:44.110 --> 00:09:45.650
We have to go to
the eights place.

00:09:45.650 --> 00:09:50.710
So we have 1 eight, 0
fours, 0 twos, and 0 ones.

00:09:50.710 --> 00:09:53.000
This right here, it might
look like 1,000 to you,

00:09:53.000 --> 00:09:55.930
but it would be 1,000
if we were in base 10.

00:09:55.930 --> 00:09:59.310
In base 2 this is
this many objects.

00:09:59.310 --> 00:10:02.350
This is eight objects in base 2.

00:10:02.350 --> 00:10:05.100
When you increment it
one, we'll have this many,

00:10:05.100 --> 00:10:07.000
we'll have 1 eight and
then we'll have 1 one.

00:10:07.000 --> 00:10:10.660
So it would be 1001.

00:10:10.660 --> 00:10:15.210
And then I'll stop here at what
we consider to be 10 objects.

00:10:15.210 --> 00:10:19.490
In base 10 you would
say you have 1 eight,

00:10:19.490 --> 00:10:24.140
and you would need 1 two, so
0 fours, 1 two, and 0 ones.

00:10:24.140 --> 00:10:28.090
So this right here
is 10 in base 2.

00:10:28.090 --> 00:10:30.480
This is 10 in base 10.

00:10:30.480 --> 00:10:33.330
Hopefully, that doesn't
confuse you too much.


Hedge funds, venture capital, and private equity

WEBVTT
Kind: captions
Language: en

00:00:00.660 --> 00:00:02.530
One thing I probably
should make clear

00:00:02.530 --> 00:00:05.210
is that this idea of
getting a 2% management fee

00:00:05.210 --> 00:00:08.830
and then participating in
the profits at around 20%,

00:00:08.830 --> 00:00:11.040
getting this 20%
carried interest,

00:00:11.040 --> 00:00:13.710
this isn't unique
to hedge funds.

00:00:13.710 --> 00:00:16.140
This is actually the same
compensation structure

00:00:16.140 --> 00:00:18.120
that you'll normally
have at a venture capital

00:00:18.120 --> 00:00:20.849
fund or a private equity fund.

00:00:20.849 --> 00:00:22.390
And just to be clear,
venture capital

00:00:22.390 --> 00:00:25.110
really is a form
of private equity.

00:00:25.110 --> 00:00:27.070
But normally when someone
says private equity,

00:00:27.070 --> 00:00:30.740
they're not talking about
venture capital in particular.

00:00:30.740 --> 00:00:36.350
In all of these situations, the
managers will get roughly 2%

00:00:36.350 --> 00:00:38.780
for managing the fund and
they'll get 20% of the profits.

00:00:38.780 --> 00:00:41.610
The only difference really, in
terms of how it's structured,

00:00:41.610 --> 00:00:44.060
in a venture capital
or private equity fund

00:00:44.060 --> 00:00:47.050
will still have kind of
a limited partnership

00:00:47.050 --> 00:00:48.130
for the actual fund.

00:00:48.130 --> 00:00:50.005
And then they would have
a management company

00:00:50.005 --> 00:00:52.220
that gets the management
fees and the profits.

00:00:52.220 --> 00:00:55.940
The only difference is because
a hedge fund, for the most part,

00:00:55.940 --> 00:00:58.530
is probably going to invest
in public securities,

00:00:58.530 --> 00:01:00.820
it could get the money
right from the get-go

00:01:00.820 --> 00:01:03.240
and put that money to
work because it tends

00:01:03.240 --> 00:01:05.720
to invest in fairly
liquid assets.

00:01:05.720 --> 00:01:07.990
So this is fairly liquid
assets that they can just

00:01:07.990 --> 00:01:08.870
go out and buy.

00:01:08.870 --> 00:01:11.720
So a hedge fund will normally
just take as much money

00:01:11.720 --> 00:01:14.190
as it needs to invest
right from the beginning.

00:01:14.190 --> 00:01:17.060
A venture capital firm
or a private equity firm,

00:01:17.060 --> 00:01:19.140
what they'll do is
they'll say, look,

00:01:19.140 --> 00:01:21.839
I'm going to raise
$100 million fund,

00:01:21.839 --> 00:01:24.380
but I'm not going to be able to
just go out the door tomorrow

00:01:24.380 --> 00:01:25.980
and invest $100 million.

00:01:25.980 --> 00:01:27.732
In the case of a
venture capital firm,

00:01:27.732 --> 00:01:29.690
they're going to have to
look at business plans

00:01:29.690 --> 00:01:32.150
and entrepreneurs and
do their due diligence.

00:01:32.150 --> 00:01:33.692
Same thing for a
private equity firm.

00:01:33.692 --> 00:01:35.900
They're going to have to
look for companies that they

00:01:35.900 --> 00:01:37.370
might want to buy
private equity.

00:01:37.370 --> 00:01:39.770
You're normally talking
about more mature companies

00:01:39.770 --> 00:01:43.230
that maybe this firm thinks that
they can buy and turn around.

00:01:43.230 --> 00:01:44.830
Maybe more mature
companies that need

00:01:44.830 --> 00:01:46.570
some money to grow really fast.

00:01:46.570 --> 00:01:48.610
Venture capital
tends to be investing

00:01:48.610 --> 00:01:51.780
in some guys and a
business plan or maybe

00:01:51.780 --> 00:01:54.050
these smaller kind
of more, I guess

00:01:54.050 --> 00:01:56.324
we should call it,
more risky companies.

00:01:56.324 --> 00:01:57.740
But in either of
these situations,

00:01:57.740 --> 00:01:59.390
they won't just
find them tomorrow.

00:01:59.390 --> 00:02:01.265
So what they do is they
go to their investors

00:02:01.265 --> 00:02:04.090
and they get their investors
to commit a certain amount

00:02:04.090 --> 00:02:06.780
of money, to say
commit $100 million.

00:02:06.780 --> 00:02:09.500
And they'll get
the management fee

00:02:09.500 --> 00:02:11.490
on what those investors commit.

00:02:11.490 --> 00:02:13.746
But they won't take the
money right then and there.

00:02:13.746 --> 00:02:15.370
They'll take the
money as they need it.

00:02:15.370 --> 00:02:17.786
They'll do what's called a
capital call to their investors

00:02:17.786 --> 00:02:21.040
saying, hey, I just found a
good $5 million investment.

00:02:21.040 --> 00:02:25.060
I now need this percentage of
what you committed to so that I

00:02:25.060 --> 00:02:27.670
can go out and make the
investment in the hedge fund.

00:02:27.670 --> 00:02:28.810
That's not the case.

00:02:28.810 --> 00:02:30.270
All of it is up front.

00:02:30.270 --> 00:02:32.250
But it really is the
same compensation scheme.

00:02:32.250 --> 00:02:34.960
And that's why if you go to
any fancy business school,

00:02:34.960 --> 00:02:38.820
you'll find these are
kind of the careers

00:02:38.820 --> 00:02:43.210
that, at least the people
who are interested in-- I

00:02:43.210 --> 00:02:46.264
don't want to give them any kind
of characteristics-- there's

00:02:46.264 --> 00:02:48.680
a bunch of reasons why people
would want to go into these.

00:02:48.680 --> 00:02:50.790
But these are definitely
sought after careers

00:02:50.790 --> 00:02:53.620
at a lot of fancy
business schools.


Are hedge funds bad?

WEBVTT
Kind: captions
Language: en

00:00:00.218 --> 00:00:02.957
Hedge funds are talked a lot about in the press

00:00:02.957 --> 00:00:06.784
and usually with a slightly suspicious or negative tone

00:00:06.784 --> 00:00:08.807
so what I want to do in this video is think about

00:00:08.807 --> 00:00:10.354
or give us a way of thinking about

00:00:10.354 --> 00:00:13.742
whether a hedge fund, or really any financial type of organization

00:00:13.742 --> 00:00:16.607
or institution is good or bad,

00:00:16.607 --> 00:00:19.200
and I won't try to take one side or the other

00:00:19.200 --> 00:00:21.941
just give you some type of things to think about.

00:00:21.941 --> 00:00:25.075
So the first thing that sometimes is complained about

00:00:25.075 --> 00:00:26.542
when people talk about hedge funds,

00:00:26.542 --> 00:00:28.075
is that the compensation structure,

00:00:28.075 --> 00:00:31.743
because the hedge fund gets 20% of the profits

00:00:31.743 --> 00:00:34.991
but if the fund were to kind of blow up and go to zero

00:00:34.991 --> 00:00:39.025
the hedge fund manager isn't on the line for 20% of the losses

00:00:39.025 --> 00:00:42.474
people would argue that that encourages hedge fund managers

00:00:42.474 --> 00:00:48.582
to take disproportionate levels of risk

00:00:48.582 --> 00:00:51.398
and that is true to some degree

00:00:51.398 --> 00:00:54.809
but one thing that is true about hedge funds is that usually

00:00:54.809 --> 00:00:59.239
it's expected that the manager or the general partner

00:00:59.239 --> 00:01:02.098
has some of their own skin in the game

00:01:02.098 --> 00:01:05.736
so as an example, I drew a Pete Capital Fund 1

00:01:05.736 --> 00:01:08.211
the manager committed 10% of the funds

00:01:08.211 --> 00:01:10.350
and what's more important, as apposed to just the

00:01:10.350 --> 00:01:11.617
percentage of the total fund is

00:01:11.617 --> 00:01:15.868
what percentage of Pete's total net worth is in the fund?

00:01:15.868 --> 00:01:18.036
Some fund managers will put a significant amount

00:01:18.036 --> 00:01:19.933
of their own personal net worth in the fund

00:01:19.933 --> 00:01:22.818
so even though they get 20% of the upside,

00:01:22.818 --> 00:01:25.201
if the fund were to really do horribly,

00:01:25.201 --> 00:01:26.935
if it were to blow up,

00:01:26.935 --> 00:01:29.498
that manager usually will really be on the line

00:01:29.498 --> 00:01:31.535
and that's usually the job of the limited partners here

00:01:31.535 --> 00:01:35.035
we've mentioned before that versus a mutual fund

00:01:35.035 --> 00:01:38.219
the limited partners of a hedge fund need to be sophisticated,

00:01:38.219 --> 00:01:40.855
they need to be accredited investors, they need to have a certain net worth

00:01:40.855 --> 00:01:43.689
they need to show that they understand these type of instruments

00:01:43.689 --> 00:01:46.305
and so it's really the job of the limited partners

00:01:46.305 --> 00:01:48.153
and it's really in their interest

00:01:48.153 --> 00:01:50.424
to make sure that they're investing in a fund

00:01:50.424 --> 00:01:53.037
where one, Pete looks like a credible guy,

00:01:53.037 --> 00:01:56.337
Pete has some skin in the game, and hopefully

00:01:56.337 --> 00:01:58.967
a substantial amount of skin in the game relative

00:01:58.967 --> 00:02:00.984
to Pete's net worth.

00:02:00.984 --> 00:02:03.672
Pete has a reputation, and then they have to decide

00:02:03.672 --> 00:02:05.805
their own comfort level with how transparent

00:02:05.805 --> 00:02:08.386
Pete is, a lot of hedge funds won't tell their investors a lot of

00:02:08.386 --> 00:02:10.608
what they're doing with this $100,000,000

00:02:10.608 --> 00:02:12.424
sometimes they'll give a little bit more information

00:02:12.424 --> 00:02:13.572
or a little bit less,

00:02:13.572 --> 00:02:16.316
that could be a negative obviously, because who knows?

00:02:16.316 --> 00:02:19.026
Maybe they're going to Las Vegas and they're gambling away this money

00:02:19.026 --> 00:02:21.134
but that's where the reputation of the manager matters a lot

00:02:21.134 --> 00:02:25.169
but also the secrecy actually could be good for the limited partners

00:02:25.169 --> 00:02:30.523
because sometimes if everyone knows exactly what's happening inside of the fund

00:02:30.523 --> 00:02:32.196
and that information goes out,

00:02:32.196 --> 00:02:34.800
there could be other people that could somehow

00:02:34.800 --> 00:02:37.403
trade against the fund, or make the same investments of the fund

00:02:37.403 --> 00:02:40.119
or if this was a large fund, go ahead of that fund

00:02:40.119 --> 00:02:43.548
and try to buy whatever this fund was trying to buy ahead of time

00:02:43.548 --> 00:02:46.333
so there's kind of pros and cons to the secrecy,

00:02:46.333 --> 00:02:48.966
but that risk is definitely there,

00:02:48.966 --> 00:02:53.028
and, you know, one thing that I guess is probably interesting to point out

00:02:53.028 --> 00:02:57.187
is that this idea of getting a percentage of the upside

00:02:57.187 --> 00:03:01.484
but having very limited downside is not unique to hedge funds

00:03:01.484 --> 00:03:04.716
in fact, this is probably true of most corporate executives,

00:03:04.716 --> 00:03:08.080
in fact, most corporate executives probably don't have as much skin in the game

00:03:08.080 --> 00:03:11.003
we've all heard about golden parachutes and all of the rest

00:03:11.003 --> 00:03:16.415
if CEOs do really well, they usually get huge, huge, huge bonuses,

00:03:16.415 --> 00:03:20.233
if they do horribly and they get fired, they still get golden parachutes

00:03:20.233 --> 00:03:22.639
and that actually probably doesn't happen to hedge fund managers,

00:03:22.639 --> 00:03:25.599
so this idea of a percentage of the upside

00:03:25.599 --> 00:03:27.605
without the same percentage of the downside

00:03:27.605 --> 00:03:29.291
isn't unique to hedge funds managers,

00:03:29.291 --> 00:03:32.303
it happens to corporate executives, it happens to

00:03:32.303 --> 00:03:35.334
heads of banks, it happens to bankers generally

00:03:35.334 --> 00:03:37.252
where they get these huge bonuses in a year

00:03:37.252 --> 00:03:38.999
but in the next year, if the bank goes out of business

00:03:38.999 --> 00:03:42.271
no one asks them to kind of give back their bonuses.

00:03:42.271 --> 00:03:47.278
So I'm not going to defend it, I'm just going to say that it's not unique to hedge funds.

00:03:47.278 --> 00:03:50.561
Now the other kind of notion that sometimes people

00:03:50.561 --> 00:03:55.677
talk relative to a hedge fund is this idea of secrecy

00:03:55.677 --> 00:03:59.427
because it is not regulated, the hedge fund manager

00:03:59.427 --> 00:04:02.346
kind of has its choice of what they do over here

00:04:02.346 --> 00:04:04.917
and this secrecy, you know, I'll put a little asterix over here,

00:04:04.917 --> 00:04:08.627
because in order for these people to be willing to commit their fund

00:04:08.627 --> 00:04:10.950
the hedge fund manager has to tell them something about

00:04:10.950 --> 00:04:14.616
what he's up to, so it's up to the hedge fund manager.

00:04:14.616 --> 00:04:17.044
But some people work that the secrecy

00:04:17.044 --> 00:04:18.991
the secrecy that the hedge fund has,

00:04:18.991 --> 00:04:21.609
combined with the fact that they're allowed to invest

00:04:21.609 --> 00:04:24.226
in more, I guess you could say, exotic things

00:04:24.226 --> 00:04:26.192
they don't have to, and I want to be very clear

00:04:26.192 --> 00:04:29.053
a lot of hedge funds, even though they have this whole structure

00:04:29.053 --> 00:04:33.125
with the 2% management fee, and the 20% carried interest,

00:04:33.125 --> 00:04:35.389
a lot of hedge funds, their actual investments

00:04:35.389 --> 00:04:38.325
might look very similar to a lot of mutual funds

00:04:38.325 --> 00:04:41.009
in fact, some of them might be more conservative

00:04:41.009 --> 00:04:43.165
than many mutual funds, so it's not necessarily the case

00:04:43.165 --> 00:04:45.984
that hedge funds are doing crazy things over here.

00:04:45.984 --> 00:04:48.819
But some of them are, and so that combination

00:04:48.819 --> 00:04:53.276
of the secrecy, that they might be speculating on this or that

00:04:53.276 --> 00:04:55.750
or buying all sorts of crazy derivatives contracts

00:04:55.750 --> 00:04:59.056
that makes people feel that hey, there might be something shady

00:04:59.056 --> 00:05:00.926
going on over here.

00:05:00.926 --> 00:05:04.577
And, the way I think about it is, if the hedge fund is relatively small

00:05:04.577 --> 00:05:07.436
and $100,000,000 would actually be small in the scale of a hedge fund

00:05:07.436 --> 00:05:09.101
or I guess another way to think about it:

00:05:09.101 --> 00:05:11.835
if the assets that are controlled are relatively small

00:05:11.835 --> 00:05:14.846
because with sophisticated derivatives, with $100,000,000

00:05:14.846 --> 00:05:17.101
you can actually control much more than

00:05:17.101 --> 00:05:20.598
$100,000,000 in notional assets, but if the notional assets

00:05:20.598 --> 00:05:24.112
that the hedge fund controls are relatively small

00:05:24.112 --> 00:05:29.625
then the secrecy, and kind of the, whatever the hedge fund might do

00:05:29.625 --> 00:05:32.911
it really just puts the investors of the hedge fund at risk

00:05:32.911 --> 00:05:34.580
and so it's really these people's job,

00:05:34.580 --> 00:05:36.779
it doesn't put society as a whole at risk

00:05:36.779 --> 00:05:39.873
the time when hedge funds get dangerous,

00:05:39.873 --> 00:05:43.961
or potentially get dangerous, or the most cited example of this

00:05:43.961 --> 00:05:46.729
is long-term capital management in the late 90s

00:05:46.729 --> 00:05:51.046
Let me write that down, LTCM, I'll do a whole series of videos on this eventually

00:05:51.046 --> 00:05:54.664
but long-term capital management controlled so much

00:05:54.664 --> 00:05:56.241
in notional funds, now we're talking about in the

00:05:56.241 --> 00:05:59.483
hundreds of billions or even trillions of dollars

00:05:59.483 --> 00:06:07.555
that this fund became too big to fail

00:06:07.555 --> 00:06:10.169
and I think you know from the recent financial crisis

00:06:10.169 --> 00:06:12.638
that this doesn't happen only to hedge funds

00:06:12.638 --> 00:06:14.382
and so you have this general notion

00:06:14.382 --> 00:06:16.254
that when any financial institution

00:06:16.254 --> 00:06:19.853
starts kind of controlling trillions of dollars

00:06:19.853 --> 00:06:21.583
or hundreds of billions of dollars,

00:06:21.583 --> 00:06:24.613
it can start a cascade through the entire financial system

00:06:24.613 --> 00:06:28.452
that's not a good thing. This is not a good thing,

00:06:28.452 --> 00:06:31.996
this is not good, because when something is too big to fail

00:06:31.996 --> 00:06:33.318
people don't let it fail

00:06:33.318 --> 00:06:35.624
and that goes against everything that we know about capitalism.

00:06:35.624 --> 00:06:38.199
Capitalism, when people do well, let them do well,

00:06:38.199 --> 00:06:41.819
but when people fail, let them fail.

00:06:41.819 --> 00:06:45.420
The thing I want to point out is that this is not unique to hedge funds

00:06:45.420 --> 00:06:51.239
AIG which is probably one of the main culprits of the last financial crisis

00:06:51.239 --> 00:06:54.377
they were an insurer, do you have the rating agencies,

00:06:54.377 --> 00:06:55.970
they weren't too big to fail

00:06:55.970 --> 00:06:58.898
but they helped kind of validate some of these other

00:06:58.898 --> 00:07:01.697
too big to fail actors. You had all of these banks

00:07:01.697 --> 00:07:03.256
that were too big to fail.

00:07:03.256 --> 00:07:05.184
So I think the general principle here is that

00:07:05.184 --> 00:07:07.176
a hedge fund can be good, it can be bad,

00:07:07.176 --> 00:07:10.168
what's unique about them relative to a mutual fund

00:07:10.168 --> 00:07:12.452
is that they tend to be a little bit more private

00:07:12.452 --> 00:07:16.376
they have more support, they should have more sophisticated investors

00:07:16.376 --> 00:07:18.036
but what they do with their money might be

00:07:18.036 --> 00:07:22.015
um, exactly the same thing as what a mutual fund

00:07:22.015 --> 00:07:24.523
might do, it might even be more conservative than a mutual fund,

00:07:24.523 --> 00:07:28.917
it might take on, it might use sophisticated instruments to take on less risk

00:07:28.917 --> 00:07:30.353
than a mutual fund,

00:07:30.353 --> 00:07:32.905
and I think the takeaway, or at least in my mind,

00:07:32.905 --> 00:07:35.747
is that any of these things, hedge funds,

00:07:35.747 --> 00:07:39.670
insurance companies, banks, even some corporations,

00:07:39.670 --> 00:07:42.627
they become bad when they become so big

00:07:42.627 --> 00:07:47.011
that failure doesn't just hurt their investors,

00:07:47.011 --> 99:59:59.999
it hurts all of society.


Hedge fund structure and fees

WEBVTT
Kind: captions
Language: en

00:00:00.590 --> 00:00:03.340
Let's see if we can understand
the structure of a hedge fund

00:00:03.340 --> 00:00:06.610
a little bit, and also how the
management and the performance

00:00:06.610 --> 00:00:08.140
fees work out.

00:00:08.140 --> 00:00:10.940
So most hedge funds,
the funds themselves

00:00:10.940 --> 00:00:13.080
are set up as
limited partnerships.

00:00:13.080 --> 00:00:15.330
So this is the hedge
fund that Pete set up,

00:00:15.330 --> 00:00:17.620
we'll call Pete Capital Fund 1.

00:00:17.620 --> 00:00:20.420
He's maybe in the future going
to start Fund 2, and Fund 3,

00:00:20.420 --> 00:00:21.760
and all of the rest.

00:00:21.760 --> 00:00:24.210
And he's able to
raise $100 million.

00:00:24.210 --> 00:00:27.420
10% of that $100 million,
or $10 million of it,

00:00:27.420 --> 00:00:28.590
is coming from him.

00:00:28.590 --> 00:00:30.380
Or I guess to be
more exact, it's

00:00:30.380 --> 00:00:34.180
coming from Pete Capital
Management, LLC, limited

00:00:34.180 --> 00:00:36.850
liability company,
which he starts off

00:00:36.850 --> 00:00:40.136
as the general
partner of this fund.

00:00:40.136 --> 00:00:41.760
And it might be a
little bit confusing,

00:00:41.760 --> 00:00:43.450
but this is one company.

00:00:43.450 --> 00:00:45.450
This is another
company over here.

00:00:45.450 --> 00:00:49.070
This company is going to manage
the assets of that company.

00:00:49.070 --> 00:00:52.160
And in return, it will be
able to get management fees.

00:00:52.160 --> 00:00:54.410
And it will be able to
get the performance fees.

00:00:54.410 --> 00:00:56.010
And we'll talk about
that in a second.

00:00:56.010 --> 00:00:59.000
And probably, Pete owns
this entire company.

00:00:59.000 --> 00:01:01.550
But he might have a couple
of employees, probably four

00:01:01.550 --> 00:01:02.151
or five.

00:01:02.151 --> 00:01:04.150
Now, the way it works
with a limited partnership

00:01:04.150 --> 00:01:06.510
is they don't call it
necessarily shares,

00:01:06.510 --> 00:01:08.190
but it's essentially
the same thing.

00:01:08.190 --> 00:01:10.110
Someone who, out of
this $100 million

00:01:10.110 --> 00:01:13.130
contributed $30
million, would get 30%

00:01:13.130 --> 00:01:14.940
in the limited partner interest.

00:01:14.940 --> 00:01:17.950
Someone who contributed
10% would get $10 million

00:01:17.950 --> 00:01:19.970
in limited partner interests.

00:01:19.970 --> 00:01:23.370
So let's just say that he does
really good over the next year.

00:01:23.370 --> 00:01:25.890
That he's able to, on a gross
basis, before we take out

00:01:25.890 --> 00:01:27.570
his management fee
or anything else,

00:01:27.570 --> 00:01:30.240
grow the fund by $20 million.

00:01:30.240 --> 00:01:32.290
So roughly on a
gross basis, 20%.

00:01:32.290 --> 00:01:35.370
But this is net of the
trading fees and all the stuff

00:01:35.370 --> 00:01:38.800
that he has to pay, the broker
and all of that type of thing.

00:01:38.800 --> 00:01:42.340
To understand what goes to
Pete Capital Management,

00:01:42.340 --> 00:01:45.770
that Pete can use to pay himself
and his handful of employees,

00:01:45.770 --> 00:01:47.360
first to guess the
management fee.

00:01:47.360 --> 00:01:50.807
And the management fee will be
on the average net asset value.

00:01:50.807 --> 00:01:53.390
And I'm going to do it a little
bit back-of-the-envelope right

00:01:53.390 --> 00:01:53.690
over here.

00:01:53.690 --> 00:01:55.280
It's normally done
on a monthly basis.

00:01:55.280 --> 00:01:57.113
But I want to go into
all of the accounting.

00:01:57.113 --> 00:01:58.984
But if he did this
fairly linearly,

00:01:58.984 --> 00:02:00.650
or if you does this
fairly consistently,

00:02:00.650 --> 00:02:02.425
the average net asset
value over the year

00:02:02.425 --> 00:02:05.110
would be about $110 million.

00:02:05.110 --> 00:02:10.060
So average would be
approximately $110 million.

00:02:10.060 --> 00:02:11.790
And so he'll get
about 2% of that.

00:02:11.790 --> 00:02:16.310
We're assuming he gets a 2%
management and 20% performance

00:02:16.310 --> 00:02:20.200
fee, or 20% carried interest,
it's sometimes called.

00:02:20.200 --> 00:02:23.640
So if the average net asset
value is $110 million,

00:02:23.640 --> 00:02:26.170
you multiply that times 2%.

00:02:26.170 --> 00:02:31.060
And then that means that he's
going to get $2.2 million

00:02:31.060 --> 00:02:31.940
in management fees.

00:02:31.940 --> 00:02:35.360
And this is for his salary,
his employee's salary,

00:02:35.360 --> 00:02:36.990
to pay the rent,
to I don't know,

00:02:36.990 --> 00:02:39.360
get some fancy computers,
whatever it might be.

00:02:39.360 --> 00:02:44.230
This is kind of viewed as the
cost just to manage the fund.

00:02:44.230 --> 00:02:47.160
So we need to subtract that from
the total amount in the fund,

00:02:47.160 --> 00:02:49.118
because that's going to
the management company.

00:02:49.118 --> 00:02:51.559
So instead of $120 million
over here we're going to have,

00:02:51.559 --> 00:02:52.100
what is that?

00:02:54.950 --> 00:03:01.595
$117 million 0.8,
$117.8 million.

00:03:01.595 --> 00:03:03.470
And then we'll have to
calculate how much she

00:03:03.470 --> 00:03:05.310
gets in a performance fee.

00:03:05.310 --> 00:03:07.650
So in this situation, net
of his management fee,

00:03:07.650 --> 00:03:11.029
we have a $17.8 million gain.

00:03:11.029 --> 00:03:12.320
So let me write that over here.

00:03:12.320 --> 00:03:17.200
We have $17.8
million in profits.

00:03:17.200 --> 00:03:19.200
The way that we've
set up the performance

00:03:19.200 --> 00:03:22.030
fee, or the carried interest,
is it Pete gets 20% of it.

00:03:22.030 --> 00:03:24.610
Or more particular,
the general partner,

00:03:24.610 --> 00:03:28.250
the Pete Capital
Management, LLC,

00:03:28.250 --> 00:03:31.370
the partner that is controlling,
that as managing this fund,

00:03:31.370 --> 00:03:32.980
will get 20%.

00:03:32.980 --> 00:03:36.500
So let's multiply
that times 20%.

00:03:36.500 --> 00:03:37.650
And what does that give us?

00:03:37.650 --> 00:03:42.900
That gives us $3.56 million.

00:03:42.900 --> 00:03:51.210
So $3.56 million will also go
to Pete Capital Management.

00:03:51.210 --> 00:03:51.850
So not bad.

00:03:51.850 --> 00:03:55.860
In this year he made a
little-- almost $6 million.

00:03:55.860 --> 00:03:58.020
And that's probably
going to go to him

00:03:58.020 --> 00:04:00.290
and probably four
or five employees.

00:04:00.290 --> 00:04:02.710
So it can, if someone
performs well,

00:04:02.710 --> 00:04:06.030
it can be a very
profitable business.

00:04:06.030 --> 00:04:08.260
And just to make it clear
how the mechanics work here

00:04:08.260 --> 00:04:12.070
is that these funds tend
to be open end funds,

00:04:12.070 --> 00:04:13.520
like open end mutual funds.

00:04:13.520 --> 00:04:16.269
Well not like them,
they have to be private.

00:04:16.269 --> 00:04:18.630
They could only take money
from accredited investors.

00:04:18.630 --> 00:04:20.112
They can't market themselves.

00:04:20.112 --> 00:04:21.820
They don't have to
register with the SEC.

00:04:21.820 --> 00:04:24.600
But when I say that they can
be open-ended it means that

00:04:24.600 --> 00:04:26.300
at any point-- well
not at any point,

00:04:26.300 --> 00:04:28.640
usually this is restricted--
at certain points

00:04:28.640 --> 00:04:30.870
in time the
investors are allowed

00:04:30.870 --> 00:04:33.339
to redeem, or kind
of add investments,

00:04:33.339 --> 00:04:34.630
to what's going on in the fund.

00:04:34.630 --> 00:04:38.630
So let's say after the end of
the year, so instead of $117.8,

00:04:38.630 --> 00:04:41.660
we're going to have to
subtract $3.56 from that

00:04:41.660 --> 00:04:43.499
for Pete Capital Management.

00:04:43.499 --> 00:04:45.290
So what's left in the
fund is going to be--

00:04:45.290 --> 00:04:46.810
and he could leave it
in there to reinvest,

00:04:46.810 --> 00:04:48.460
but that would just
increase his share.

00:04:48.460 --> 00:04:50.920
But let's say Pete Capital
Management takes it out.

00:04:50.920 --> 00:04:53.830
So we'll be left
with-- let's see

00:04:53.830 --> 00:05:11.370
we have 117.8 minus
it gives us 114.24.

00:05:11.370 --> 00:05:15.580
So over here, what's left
of the fund is 114.24.

00:05:15.580 --> 00:05:17.340
And let's say this
period, investors

00:05:17.340 --> 00:05:19.500
are allowed to redeem
their interest.

00:05:19.500 --> 00:05:21.410
And let's say this
guy right over here,

00:05:21.410 --> 00:05:24.540
this guy with the 30% interest,
he says, you know what?

00:05:24.540 --> 00:05:25.950
That was a pretty good year.

00:05:25.950 --> 00:05:28.181
I want to take 10%
of my interest out.

00:05:28.181 --> 00:05:29.680
So instead of having
a 30% interest,

00:05:29.680 --> 00:05:31.780
he wants to have a 10% interest.

00:05:31.780 --> 00:05:33.860
So what happens is,
so instead of a 30%

00:05:33.860 --> 00:05:35.740
this is now 20% interest.

00:05:35.740 --> 00:05:37.260
He'll take 10% out.

00:05:37.260 --> 00:05:40.850
So he'll take 10% of 114.24.

00:05:40.850 --> 00:05:42.860
So he's going to take
out-- that's essentially

00:05:42.860 --> 00:05:46.010
going to be-- we just have
to move the decimal places

00:05:46.010 --> 00:05:46.750
one over.

00:05:46.750 --> 00:05:50.977
So he's going to take
out $11.424 million.

00:05:50.977 --> 00:05:52.310
That's this guy right over here.

00:05:52.310 --> 00:05:56.270
He's going to take
out $11.424 million.

00:05:56.270 --> 00:05:59.580
And then the fund will
decrease by that amount.

00:05:59.580 --> 00:06:02.479
So he can, at these specific
periods, people can redeem.

00:06:02.479 --> 00:06:04.020
Usually it's at the
end of the month,

00:06:04.020 --> 00:06:07.062
at the end of the quarter,
or the end of the year.

00:06:07.062 --> 00:06:08.520
So then the fund
will be left with,

00:06:08.520 --> 00:06:11.650
what's 114-- let me take
the calculator out again.

00:06:11.650 --> 00:06:21.880
The fund will now be left
with 114.24 minus 11.424

00:06:21.880 --> 00:06:27.814
which is going to be 102.816.

00:06:27.814 --> 00:06:29.230
And at the same
time, other people

00:06:29.230 --> 00:06:31.200
might say, hey, that was
a pretty good return.

00:06:31.200 --> 00:06:33.480
I'm going to now
contribute to the fund.

00:06:33.480 --> 00:06:35.030
So either way,
it's not like it's

00:06:35.030 --> 00:06:37.250
a closed-end fund where
just at the beginning,

00:06:37.250 --> 00:06:39.700
people can commit their capital
and they can't take it out

00:06:39.700 --> 00:06:43.100
until the end of the fund,
or they can't add more.

00:06:43.100 --> 00:06:46.630
During the life of most hedge
funds, at specific periods,

00:06:46.630 --> 00:06:48.410
people are allowed to
redeem their funds.

00:06:48.410 --> 00:06:51.370
Or they're allowed
to add more funds.


Hedge funds intro

WEBVTT
Kind: captions
Language: en

00:00:00.500 --> 00:00:03.590
In this video I want to
see if we can understand

00:00:03.590 --> 00:00:06.610
the idea of a hedge fund
a little bit better.

00:00:06.610 --> 00:00:09.380
And these tend to be
pretty mysterious,

00:00:09.380 --> 00:00:12.890
and sometimes get a bad name
because some hedge funds do

00:00:12.890 --> 00:00:16.352
do some fairly strange
things and secretive things

00:00:16.352 --> 00:00:16.935
in the market.

00:00:16.935 --> 00:00:21.610
So people are, rightfully so,
suspicious of many of them.

00:00:21.610 --> 00:00:24.310
But the real difference between
a hedge fund and the types

00:00:24.310 --> 00:00:26.690
of mutual funds that
we just talked about

00:00:26.690 --> 00:00:28.510
are that they're not
regulated by the SEC.

00:00:34.330 --> 00:00:36.430
And because they
are not regulated

00:00:36.430 --> 00:00:39.550
they can't market themselves.

00:00:39.550 --> 00:00:43.110
That's why when you
watch financial shows,

00:00:43.110 --> 00:00:45.440
or you get a magazine,
a finance magazine

00:00:45.440 --> 00:00:47.604
you will not see
ads for hedge funds.

00:00:47.604 --> 00:00:49.270
The mutual funds are
all over the place,

00:00:49.270 --> 00:00:50.520
marketing them left and right.

00:00:50.520 --> 00:00:53.220
Hedge funds the largest
hedge funds in the world

00:00:53.220 --> 00:00:57.200
are definitely not
even household names.

00:00:57.200 --> 00:01:00.382
Very few people even know
what those largest hedge

00:01:00.382 --> 00:01:01.340
funds in the world are.

00:01:01.340 --> 00:01:03.620
And that's because they
can't market themselves.

00:01:03.620 --> 00:01:06.480
No matter how good
of a track record,

00:01:06.480 --> 00:01:08.170
or really how
reasonable of a fund

00:01:08.170 --> 00:01:10.910
they might be-- some might
not be reasonable, some are--

00:01:10.910 --> 00:01:12.530
they can't market themselves.

00:01:12.530 --> 00:01:14.630
And they also can't take
money from the public.

00:01:21.420 --> 00:01:23.580
So in general, in order
to invest in a hedge fund,

00:01:23.580 --> 00:01:25.413
you have to be an
accredited investor, which

00:01:25.413 --> 00:01:27.112
means you have a
certain net worth,

00:01:27.112 --> 00:01:28.570
or maybe you have
a certain income,

00:01:28.570 --> 00:01:30.480
or maybe by virtue
of your education

00:01:30.480 --> 00:01:33.420
you can prove that you have a
certain level of sophistication

00:01:33.420 --> 00:01:35.710
to invest in these things
that aren't regulated.

00:01:35.710 --> 00:01:40.510
You, I guess, don't need
the SEC to watch your back.

00:01:40.510 --> 00:01:42.320
So the regulation
is a key difference.

00:01:42.320 --> 00:01:43.985
Marketing, no money
from the public.

00:01:43.985 --> 00:01:45.360
And then the other
key difference

00:01:45.360 --> 00:01:49.130
is how the managers
tend to be incented.

00:01:49.130 --> 00:01:52.040
I know incented is not
a word, or motivated.

00:01:52.040 --> 00:01:54.670
In the mutual fund
world, managers

00:01:54.670 --> 00:01:56.690
get a percent of assets.

00:01:56.690 --> 00:01:59.670
So for mutual fund
manager, larger is better.

00:01:59.670 --> 00:02:01.684
The more under
management the more money

00:02:01.684 --> 00:02:03.350
the mutual fund
manager's going to make.

00:02:03.350 --> 00:02:05.370
So they really just want to
keep marketing it, marketing it,

00:02:05.370 --> 00:02:06.010
marketing it.

00:02:06.010 --> 00:02:08.560
They don't get a
cut of the profits.

00:02:08.560 --> 00:02:13.250
So you really there's not a lot
of incentive to kind of really

00:02:13.250 --> 00:02:14.290
beat the market here.

00:02:14.290 --> 00:02:17.170
Because if they kind of don't
be the market one year, then

00:02:17.170 --> 00:02:20.810
all of a sudden, their
fund will shrink.

00:02:20.810 --> 00:02:24.560
So they really just get a
fee on the size of the fund.

00:02:24.560 --> 00:02:27.530
In a hedge fund, and
usually the implication

00:02:27.530 --> 00:02:30.080
is that a hedge fund will
be more actively managed,

00:02:30.080 --> 00:02:32.520
they'll get a larger
management fees.

00:02:32.520 --> 00:02:40.020
So larger management fee,
instead of the 1%, 1%

00:02:40.020 --> 00:02:41.520
is actually a lot
for mutual fund.

00:02:41.520 --> 00:02:45.060
Instead of that, hedge
funds tend to be 1% to 2%.

00:02:45.060 --> 00:02:49.000
So 1% to 2% management fee,
and sometimes even larger

00:02:49.000 --> 00:02:49.500
than that.

00:02:49.500 --> 00:02:51.540
But the even I guess
bigger difference,

00:02:51.540 --> 00:02:52.915
and this is where
hedge funds are

00:02:52.915 --> 00:02:54.880
very different from a
traditional mutual fund,

00:02:54.880 --> 00:02:57.800
is that the management
company, the general partner,

00:02:57.800 --> 00:03:00.890
gets a percentage
of the profits.

00:03:00.890 --> 00:03:03.870
So with a hedge fund manager
or the management company,

00:03:03.870 --> 00:03:11.150
the going rate tends to be about
20$ of the profits of the fund.

00:03:11.150 --> 00:03:14.140
Sometimes it's less,
sometimes it's a lot more.

00:03:14.140 --> 00:03:18.240
Some very successful hedge
funds get 25%, 30% or even

00:03:18.240 --> 00:03:20.804
a larger percentage
of the profits.

00:03:20.804 --> 00:03:22.720
So with that out of the
way in the next video,

00:03:22.720 --> 00:03:26.010
I'm going to do some different
mechanics of essentially

00:03:26.010 --> 00:03:28.260
the same returns,
but one by hedge fund

00:03:28.260 --> 00:03:31.610
and then one by a
traditional mutual fund.


Exchange traded funds (ETFs)

WEBVTT
Kind: captions
Language: en

00:00:00.630 --> 00:00:03.380
So far, we looked at
open-end mutual funds

00:00:03.380 --> 00:00:07.450
that can kind of grow and shrink
depending on how many investors

00:00:07.450 --> 00:00:09.250
want to invest in that fund.

00:00:09.250 --> 00:00:11.560
They can grow by
creating new shares

00:00:11.560 --> 00:00:13.726
and selling those shares
to the general public.

00:00:13.726 --> 00:00:16.100
And they can shrink because
someone who wants their money

00:00:16.100 --> 00:00:18.610
back goes to the
fund and says, you

00:00:18.610 --> 00:00:22.130
have to buy this back
from me at the end NAV,

00:00:22.130 --> 00:00:24.482
at the net asset
value, per share.

00:00:24.482 --> 00:00:26.190
But the problem with
it, actually there's

00:00:26.190 --> 00:00:28.180
a couple problems, is
that the manager here

00:00:28.180 --> 00:00:32.170
has to always keep a little
cash set aside in case some

00:00:32.170 --> 00:00:34.760
of the investors come
to him and say, hey,

00:00:34.760 --> 00:00:36.690
I want you to buy my share back.

00:00:36.690 --> 00:00:37.717
I want liquidity.

00:00:37.717 --> 00:00:39.800
And the other thing that
they have to worry about,

00:00:39.800 --> 00:00:41.591
at least from the
investor's point of view,

00:00:41.591 --> 00:00:45.600
is they can only buy or
sell at the end of the day.

00:00:45.600 --> 00:00:49.110
And that will only happen at
the net asset value per share.

00:00:49.110 --> 00:00:51.184
And on top of that,
the fund manager,

00:00:51.184 --> 00:00:52.600
or whoever's running
the fund, has

00:00:52.600 --> 00:00:55.760
to worry about
actually transacting

00:00:55.760 --> 00:00:58.136
between all of these
different investors.

00:00:58.136 --> 00:00:59.510
Now, on the other
side of things,

00:00:59.510 --> 00:01:01.230
we looked at the
closed-end fund.

00:01:01.230 --> 00:01:04.000
The closed-end fund
couldn't kind of dynamically

00:01:04.000 --> 00:01:07.740
grow and shrink by creating new
shares, or by buying them back.

00:01:07.740 --> 00:01:10.350
But what was good about them
is, is that they were freely

00:01:10.350 --> 00:01:14.150
trading on exchanges, maybe
on the NASDAQ or the New York

00:01:14.150 --> 00:01:15.100
Stock Exchange.

00:01:15.100 --> 00:01:18.370
And because there was none of
this kind of back and forth

00:01:18.370 --> 00:01:21.580
between the fund
managers, or whoever

00:01:21.580 --> 00:01:25.000
was kind of doing the operations
of the fund and the investors,

00:01:25.000 --> 00:01:26.600
they didn't have
to put cash aside.

00:01:26.600 --> 00:01:29.150
And they didn't have to have
all of this kind of overhead

00:01:29.150 --> 00:01:30.400
in dealing with the investors.

00:01:30.400 --> 00:01:32.566
Now, you're probably saying,
well isn't there a way?

00:01:32.566 --> 00:01:35.810
Or maybe there's a way to
get the best of both worlds?

00:01:35.810 --> 00:01:37.950
A fund that could
grow dynamically,

00:01:37.950 --> 00:01:40.370
that could create
new shares when

00:01:40.370 --> 00:01:42.150
there was demand from investors.

00:01:42.150 --> 00:01:44.130
But at the same time,
those new shares

00:01:44.130 --> 00:01:46.960
could be traded
on an open market.

00:01:46.960 --> 00:01:49.250
And that combination, or
you can kind of view it

00:01:49.250 --> 00:01:51.920
as a combination of the
two, actually exists,

00:01:51.920 --> 00:02:00.990
and they're called
exchange traded funds,

00:02:00.990 --> 00:02:03.682
or ETFs for short.

00:02:03.682 --> 00:02:04.890
And you might say, hey, wait.

00:02:04.890 --> 00:02:07.160
Isn't a closed-end
fund exchange traded?

00:02:07.160 --> 00:02:07.960
And it is.

00:02:07.960 --> 00:02:12.630
These actually do trade
hands on the stock exchanges.

00:02:12.630 --> 00:02:14.780
But these are officially ETFs.

00:02:14.780 --> 00:02:17.745
When someone tells you an ETF,
the way to think about it,

00:02:17.745 --> 00:02:19.510
it's a combination of both.

00:02:19.510 --> 00:02:22.880
But what it does is it
limits of the interaction.

00:02:22.880 --> 00:02:26.320
So when you have just a
regular, open-end mutual fund

00:02:26.320 --> 00:02:28.700
any individual investor
can come to the fund

00:02:28.700 --> 00:02:30.260
say, here is my share.

00:02:30.260 --> 00:02:31.400
Buy it back from me.

00:02:31.400 --> 00:02:32.490
Eliminate that share.

00:02:32.490 --> 00:02:34.370
And that creates a
lot of overhead here.

00:02:34.370 --> 00:02:38.390
On an exchange traded
fund only approved people,

00:02:38.390 --> 00:02:40.580
and these are usually
large institutions,

00:02:40.580 --> 00:02:42.900
can go to the fund
and say, I want

00:02:42.900 --> 00:02:46.472
to buy or redeem a
big block of shares.

00:02:46.472 --> 00:02:47.930
So an exchange
traded fund, instead

00:02:47.930 --> 00:02:49.390
of creating one
share of time, it

00:02:49.390 --> 00:02:53.430
might create 5,000, or 10,000,
or 100,000 shares at a time.

00:02:53.430 --> 00:02:55.280
And on the other side
of things, if someone

00:02:55.280 --> 00:02:57.050
wanted to redeem
their shares, they

00:02:57.050 --> 00:03:00.630
would redeem 5,000,
10,000, or 100,000 shares

00:03:00.630 --> 00:03:01.860
at the same time.

00:03:01.860 --> 00:03:04.300
And what's good there from
the funds point of view,

00:03:04.300 --> 00:03:05.065
is that they don't
have to deal with all

00:03:05.065 --> 00:03:06.440
of these small transactions.

00:03:06.440 --> 00:03:09.870
They can do big transactions
with big entities.

00:03:09.870 --> 00:03:12.840
So that saves them
cost on overhead.

00:03:12.840 --> 00:03:16.430
And since these big
people go and kind of

00:03:16.430 --> 00:03:19.687
by these big blocks of shares,
they can then go and sell them

00:03:19.687 --> 00:03:21.520
in the open market, or
they could trade them

00:03:21.520 --> 00:03:22.410
in the open market.

00:03:22.410 --> 00:03:26.680
So if want to buy in to an ETF,
instead of buying it directly

00:03:26.680 --> 00:03:29.540
from the ETF you
would buy it from one

00:03:29.540 --> 00:03:32.740
of these big institutions
that buy big blocks of shares.

00:03:32.740 --> 00:03:35.120
So they're now
buying a big block

00:03:35.120 --> 00:03:38.670
of-- maybe this is 10,000
shares right over here.

00:03:38.670 --> 00:03:41.670
And then they will trade
in the open market.

00:03:41.670 --> 00:03:44.820
So you kind of get the
best of both worlds and.

00:03:44.820 --> 00:03:47.130
In general, ETFs
also have lower fees.

00:03:47.130 --> 00:03:48.880
And they have lower
fees one, because they

00:03:48.880 --> 00:03:50.671
don't have to do all
of this back and forth

00:03:50.671 --> 00:03:52.710
between each
individual investor.

00:03:52.710 --> 00:03:55.760
And most ETFs are
not actively managed.

00:03:55.760 --> 00:03:59.220
And when I say actively managed
I'm talking about the situation

00:03:59.220 --> 00:04:00.080
where you had Pete.

00:04:00.080 --> 00:04:02.660
And Pete says that he's just
an awesome stock picker.

00:04:02.660 --> 00:04:04.200
He can beat the market.

00:04:04.200 --> 00:04:07.139
He can do all of-- you know he
really researches companies.

00:04:07.139 --> 00:04:08.680
And he thinks that
there's some value

00:04:08.680 --> 00:04:10.110
that he creates by doing that.

00:04:10.110 --> 00:04:11.850
When something is
not actively managed,

00:04:11.850 --> 00:04:14.270
and exchange traded funds tend
to not be, they're saying,

00:04:14.270 --> 00:04:16.690
look, we're just going
to buy the market.

00:04:16.690 --> 00:04:18.680
Or we're just going
to buy some commodity.

00:04:18.680 --> 00:04:20.810
So when you go into an
exchange traded fund,

00:04:20.810 --> 00:04:23.320
you're really just trying
to buy some asset class,

00:04:23.320 --> 00:04:26.690
maybe it's the S&P 500.

00:04:26.690 --> 00:04:28.720
Maybe it's some type of
exchange traded funds

00:04:28.720 --> 00:04:30.840
that buys gold as assets.

00:04:30.840 --> 00:04:33.280
Or maybe it's buying some
other type of commodity.

00:04:33.280 --> 00:04:35.027
And so because it's
not actively managed,

00:04:35.027 --> 00:04:36.610
the argument would
be, that they don't

00:04:36.610 --> 00:04:37.972
need as much in management fees.

00:04:37.972 --> 00:04:39.180
So they will have lower fees.

00:04:42.220 --> 00:04:45.540
So it's a combination, they
can grow arbitrarily large,

00:04:45.540 --> 00:04:50.140
and some of the largest exchange
traded funds are super huge.

00:04:50.140 --> 00:04:52.190
They have much lower fees.

00:04:52.190 --> 00:04:54.010
And they have this tradability.

00:04:54.010 --> 00:04:56.610
You can trade them at any
kind of second on the market.

00:04:56.610 --> 00:04:58.110
You don't have to
wait until the end

00:04:58.110 --> 00:05:01.390
of the day like
an open-end fund.


Closed-end mutual funds

WEBVTT
Kind: captions
Language: en

00:00:00.962 --> 00:00:05.412
In the last video we had Pete starting an open-ended mutual fund

00:00:05.412 --> 00:00:08.171
that was managed by Pete Inc.

00:00:08.171 --> 00:00:11.146
Mutual Funds normally have nice grand names

00:00:11.146 --> 00:00:12.729
maybe they called this the Saturn Fund

00:00:12.729 --> 00:00:15.997
and if there is a Saturn Fund out there, I just picked that name at random

00:00:15.997 --> 00:00:19.930
I'm not implying that this is you or anything like that

00:00:25.530 --> 00:00:27.514
I just made up that name on the fly

00:00:27.514 --> 00:00:31.279
But it's managed by Pete Inc. and we called it an open-ended fund

00:00:31.279 --> 00:00:34.995
because at any time one of the people who owned a share

00:00:34.995 --> 00:00:38.548
or unit in the fund can redeem it back from the fund

00:00:38.548 --> 00:00:40.978
that Pete or the management company would say

00:00:40.978 --> 00:00:45.496
If you want your $180 back we'll buy that

00:00:45.496 --> 00:00:50.780
we'll give you $180, you give back the share, and then we cancel the share

00:00:50.780 --> 00:00:53.811
and if anyone wants to add to the fund

00:00:53.811 --> 00:00:54.546
if they want to invest

00:00:54.546 --> 00:00:57.413
the corporation can create new shares

00:00:57.413 --> 00:00:59.849
and then issue it to people - sell it to people

00:00:59.849 --> 00:01:02.770
and their money would go into the common pool

00:01:02.770 --> 00:01:05.353
and the management company would take fees off of it

00:01:05.353 --> 00:01:07.214
But that probably had you asking

00:01:07.214 --> 00:01:10.767
If this is an open-ended fund, what is a closed-ended fund

00:01:10.767 --> 00:01:11.786
or do they even exist?

00:01:11.786 --> 00:01:13.097
And they do

00:01:13.097 --> 00:01:15.099
That's what I'm going to talk about here

00:01:15.099 --> 00:01:18.680
Closed-end funds

00:01:18.680 --> 00:01:21.330
and closed-end funds on some level are a little bit simpler

00:01:21.330 --> 00:01:23.396
What happens in a closed-end fund is that

00:01:23.396 --> 00:01:26.349
all of the investors are essentially

00:01:26.349 --> 00:01:29.813
Or I guess you can say that the share structure

00:01:29.813 --> 00:01:31.630
is locked from the beginning

00:01:31.630 --> 00:01:34.129
So if Pete wanted to start a closed-end mutual fund

00:01:34.129 --> 00:01:37.647
he would once again register a corporation with the SEC

00:01:37.647 --> 00:01:38.979
he would market it it

00:01:38.979 --> 00:01:41.548
he would tell everyone "Hey I'm Pete, I'm an awesome investor"

00:01:41.548 --> 00:01:43.165
"Here's my track record"

00:01:43.165 --> 00:01:45.446
and then he would just get a bunch of investors

00:01:45.446 --> 00:01:48.131
so lets say he's able to find 20 investors

00:01:48.131 --> 00:01:49.616
and that's all he's able to find

00:01:49.616 --> 00:01:52.030
so this is 20 right here, and I'm not going to count

00:01:52.030 --> 00:01:55.130
but, let's say that there's 20 slices right over here

00:01:55.130 --> 00:01:59.703
He gets 20 people, so let's say they each give $100

00:01:59.703 --> 00:02:04.594
so he is able to raise $2000. 20 times $100

00:02:04.594 --> 00:02:07.611
So he is able to raise $2000

00:02:07.611 --> 00:02:11.362
And once that happens, the fund is closed.

00:02:11.362 --> 00:02:14.350
Pete's going to do his best to manage this

00:02:14.350 --> 00:02:19.682
So Pete will manage this and he will still take a management fee

00:02:19.682 --> 00:02:21.782
Maybe the same 1%

00:02:21.782 --> 00:02:23.764
But what's fundamentally different here

00:02:23.764 --> 00:02:26.515
and he can market - well he doesn't have to market the fund anymore

00:02:26.515 --> 00:02:28.846
because he can no longer get new investors

00:02:28.846 --> 00:02:30.213
and this is actually the main difference

00:02:30.213 --> 00:02:31.914
An open-ended mutual fund

00:02:31.914 --> 00:02:33.548
at any point in time

00:02:33.548 --> 00:02:35.580
or I should say at the end of trading

00:02:35.580 --> 00:02:39.265
at the end of a day, they can lose investors, or they can gain investors

00:02:39.265 --> 00:02:41.130
so it's an incentive for an open-ended fund

00:02:41.130 --> 00:02:42.380
to constantly market itself

00:02:42.380 --> 00:02:44.687
because the manager wants to manage more money

00:02:44.687 --> 00:02:47.331
so that he gets more of a management fee

00:02:47.331 --> 00:02:48.182
And a closed-end fund

00:02:48.182 --> 00:02:50.214
They'll market it right when they are creating the fund

00:02:50.214 --> 00:02:51.730
But once they create it

00:02:51.730 --> 00:02:54.516
So lets say he just got his 20 investors

00:02:54.516 --> 00:02:56.148
Then it is closed

00:02:56.148 --> 00:02:59.714
He can't create any more shares

00:02:59.714 --> 00:03:01.383
or cancel any more shares

00:03:01.383 --> 00:03:02.813
But what can happen

00:03:02.813 --> 00:03:03.881
so you might say

00:03:03.881 --> 00:03:04.829
well in a closed-end fund

00:03:04.829 --> 00:03:06.433
How do these people let's say you're holding

00:03:06.433 --> 00:03:07.932
one of these shares

00:03:07.932 --> 00:03:10.063
let's say that you're holding one share

00:03:10.063 --> 00:03:11.332
right over here

00:03:11.332 --> 00:03:12.182
what happens if you want to

00:03:12.182 --> 00:03:16.099
If you need to buy a house, or if you owe money to somebody

00:03:16.099 --> 00:03:19.481
so you want to get the value of your share back

00:03:19.481 --> 00:03:20.731
and the answer with a closed-end fund

00:03:20.731 --> 00:03:24.382
is that you would then go sell your share to someone else

00:03:24.382 --> 00:03:26.921
so this right here you can trade it

00:03:26.921 --> 00:03:28.648
You can trade it

00:03:28.648 --> 00:03:30.731
and you would trade it just you would

00:03:30.731 --> 00:03:31.965
trade the stock of any company

00:03:31.965 --> 00:03:33.635
And in fact when you go and buy or sell

00:03:33.635 --> 00:03:36.064
a stock of IBM, most of the time

00:03:36.064 --> 00:03:38.131
you're just buying or selling it from someone else

00:03:38.131 --> 00:03:39.854
You're not transacting with IBM

00:03:39.854 --> 00:03:40.850
the company

00:03:40.850 --> 00:03:43.165
You're trading in the secondary market

00:03:43.165 --> 00:03:45.188
you're not dealing with the actual corporation

00:03:45.188 --> 00:03:47.632
so that's where the investor

00:03:47.632 --> 00:03:49.130
get's their liquidity

00:03:49.130 --> 00:03:50.132
and when we say liquidity

00:03:50.132 --> 00:03:51.914
it allows them to convert it into cash

00:03:51.914 --> 00:03:53.947
because they can trade it

00:03:53.947 --> 00:03:55.352
So the big difference

00:03:55.352 --> 00:03:58.626
open-ended fund: when an investor wants their money back

00:03:58.626 --> 00:04:03.301
they have to deal with the fund itself

00:04:03.301 --> 00:04:05.215
the fund will buy back their share

00:04:05.215 --> 00:04:07.149
If some wants to invest in a fund

00:04:07.149 --> 00:04:08.601
the fund will sell them the share

00:04:08.601 --> 00:04:10.481
so they're always dealing with the fund itself

00:04:10.481 --> 00:04:12.048
in a closed-end fund

00:04:12.048 --> 00:04:15.249
once the fund is created it's share pool is fixed

00:04:15.249 --> 00:04:17.716
and if someone wants to buy or sell a share

00:04:17.716 --> 00:04:19.302
it happens in the secondary market

00:04:19.302 --> 00:04:21.066
so they're buying and selling from each other

00:04:21.066 --> 00:04:23.601
they're not dealing with the actual fund manager

00:04:23.601 --> 00:04:25.544
The disadvantage from the fund manager here

00:04:25.544 --> 00:04:26.999
is it's much less flexible

00:04:26.999 --> 00:04:29.065
in terms of growing or shrinking the fund

00:04:29.065 --> 00:04:31.781
The advantage is this fund manager

00:04:31.781 --> 00:04:33.799
doesn't have to keep cash around

00:04:33.799 --> 00:04:36.933
in case the share holders want to redeem

00:04:36.933 --> 00:04:39.616
In the open-ended fund we saw that the manager

00:04:39.616 --> 00:04:42.171
has to keep some cash around in case one of these

00:04:42.171 --> 00:04:43.466
investors wants their money back

00:04:43.466 --> 00:04:45.881
here - the closed-end fund - he knows that no one

00:04:45.881 --> 00:04:46.982
can get their money back right here

00:04:46.982 --> 99:59:59.999
so he or she can invest as they see fit


Open-end mutual fund redemptions (part 2)

WEBVTT
Kind: captions
Language: en

00:00:00.500 --> 00:00:03.580
Let's continue with the
story of Pete's mutual fund.

00:00:03.580 --> 00:00:07.530
So let's say that a year goes by
and that even after paying Pete

00:00:07.530 --> 00:00:11.470
the 1%, so it had $500 of
assets under management,

00:00:11.470 --> 00:00:15.217
this whole assets under
management a year later,

00:00:15.217 --> 00:00:16.800
let's say it goes
to, like I mentioned

00:00:16.800 --> 00:00:19.830
at the end of the
last video, $1,000.

00:00:19.830 --> 00:00:22.650
So Pete either is really
good at or really lucky,

00:00:22.650 --> 00:00:24.460
or a little bit of both.

00:00:24.460 --> 00:00:27.500
So it goes to $1,000.

00:00:27.500 --> 00:00:29.550
So let me draw it like this.

00:00:29.550 --> 00:00:32.100
So now it is that
$1,000, and it still

00:00:32.100 --> 00:00:34.560
has the same five
investors here.

00:00:34.560 --> 00:00:36.500
And I'm lucky enough
to be one of them.

00:00:36.500 --> 00:00:38.940
So here are the five investors.

00:00:38.940 --> 00:00:40.160
Let me draw the shares.

00:00:40.160 --> 00:00:47.050
So there's one, two,
three, four, five shares.

00:00:47.050 --> 00:00:50.310
Now, each of the
shares-- well, the $1,000

00:00:50.310 --> 00:00:53.170
is called the NAV, or
the net asset value.

00:00:53.170 --> 00:00:55.770
So let me give you that
piece of terminology,

00:00:55.770 --> 00:00:58.000
just means net asset value.

00:00:58.000 --> 00:01:00.080
And so there's an NAV per share.

00:01:00.080 --> 00:01:03.490
The NAV per share right
over here is $200.

00:01:03.490 --> 00:01:07.180
I just took the total NAV and I
just divided it by the shares.

00:01:07.180 --> 00:01:10.730
And what's special about
an open-ended mutual fund

00:01:10.730 --> 00:01:13.780
is at the close, or at
the end of every day,

00:01:13.780 --> 00:01:16.430
either new shares can
be removed from the fund

00:01:16.430 --> 00:01:18.440
or could be created
for the fund.

00:01:18.440 --> 00:01:20.580
So in the first
video, I showed how

00:01:20.580 --> 00:01:23.270
I wanted to buy into the
fund so I bought a share.

00:01:23.270 --> 00:01:24.519
And that increase the NAV.

00:01:24.519 --> 00:01:26.310
And it also increased
the number of shares.

00:01:26.310 --> 00:01:29.006
He had to create a
share for me to buy,

00:01:29.006 --> 00:01:30.880
he didn't sell me share
that already existed.

00:01:30.880 --> 00:01:33.110
So you can imagine, after
this type of performance

00:01:33.110 --> 00:01:35.400
more people would
want to buy shares.

00:01:35.400 --> 00:01:37.560
So now they would have
to buy in to make things

00:01:37.560 --> 00:01:40.020
fair at $200 per
share, because that's

00:01:40.020 --> 00:01:42.380
the current NAV per share.

00:01:42.380 --> 00:01:46.080
So let's say that five more
people want to buy in at $200

00:01:46.080 --> 00:01:47.310
per share.

00:01:47.310 --> 00:01:50.060
So what Pete would do, or
what this mutual fund--

00:01:50.060 --> 00:01:53.160
it's not Pete really,
it's the corporation--

00:01:53.160 --> 00:01:56.140
it would create five new shares.

00:01:56.140 --> 00:02:00.010
So one, two, three, four, five.

00:02:00.010 --> 00:02:01.662
If there was only
one person that day

00:02:01.662 --> 00:02:03.120
it would create
one share that day.

00:02:03.120 --> 00:02:04.703
If there was 10
people that they would

00:02:04.703 --> 00:02:05.960
create 10 shares that day.

00:02:05.960 --> 00:02:07.480
And it could keep doing this.

00:02:07.480 --> 00:02:10.160
And the NAV of each
of these are $200.

00:02:10.160 --> 00:02:13.240
So it gives the shares
to each of these people.

00:02:13.240 --> 00:02:14.790
And they had to contribute $200.

00:02:14.790 --> 00:02:19.530
So essentially it puts
another $1,000 into the pool

00:02:19.530 --> 00:02:21.450
that Pete can now manage.

00:02:21.450 --> 00:02:26.460
And so now the total NAV
for the fund is $2,000 now.

00:02:26.460 --> 00:02:29.600
And Pete will get his
1% management fee off

00:02:29.600 --> 00:02:32.860
of this entire $2,000.

00:02:32.860 --> 00:02:35.930
Now let's say that we
fast forward a little bit.

00:02:35.930 --> 00:02:38.540
We fast forward a
little bit to let's

00:02:38.540 --> 00:02:40.890
say Pete starts having
a not so good year.

00:02:40.890 --> 00:02:43.370
So let's say we fast
forward a year past that

00:02:43.370 --> 00:02:47.990
and Pete has a
negative 10% return.

00:02:47.990 --> 00:02:50.240
So if you started at
$2,000, and that's

00:02:50.240 --> 00:02:53.030
when you include taking
his management fee out,

00:02:53.030 --> 00:02:57.000
you start at $2,000, you
lose 10% in one year.

00:02:57.000 --> 00:02:59.580
So it goes down to $1,800.

00:02:59.580 --> 00:03:01.230
Let me do this in a new color.

00:03:01.230 --> 00:03:04.110
So now he's at $1,800.

00:03:04.110 --> 00:03:06.310
It's not completely
drawn to scale,

00:03:06.310 --> 00:03:08.430
but hopefully you get the idea.

00:03:08.430 --> 00:03:15.100
So now he is at $1,800.

00:03:15.100 --> 00:03:19.870
But you still have a
total of 10 shares.

00:03:19.870 --> 00:03:23.510
So let me do my best
to draw the 10 shares.

00:03:23.510 --> 00:03:30.820
So I have one, two, three, four,
five, six, seven, eight, nine,

00:03:30.820 --> 00:03:31.320
10.

00:03:31.320 --> 00:03:33.380
These should be of equal size.

00:03:33.380 --> 00:03:37.720
And now the NAV
per share is going

00:03:37.720 --> 00:03:42.080
to be 1,800 divided
by 10, or $180.

00:03:42.080 --> 00:03:44.430
And let's say that I
get a little bit freaked

00:03:44.430 --> 00:03:46.260
out by this recent performance.

00:03:46.260 --> 00:03:48.260
And I have some other
commitments with my money.

00:03:48.260 --> 00:03:52.250
So I say Pete, you need to
buy my share back from me.

00:03:52.250 --> 00:03:56.360
So what Pete does is he
would give me back $180.

00:03:56.360 --> 00:03:59.700
So the total NAV
would lose $180.

00:03:59.700 --> 00:04:01.480
So it would go down to $180.

00:04:01.480 --> 00:04:03.900
So we would take this out of it.

00:04:03.900 --> 00:04:08.110
1,800 minus 180 is 1,620.

00:04:08.110 --> 00:04:10.590
So now it is 1,620.

00:04:10.590 --> 00:04:12.490
And they would buy
back a share from me.

00:04:12.490 --> 00:04:15.040
So they would cancel
one of the shares.

00:04:15.040 --> 00:04:17.240
But notice, the NAV per
share does not change.

00:04:17.240 --> 00:04:19.709
By me redeeming my
share it does not

00:04:19.709 --> 00:04:21.649
change what happens
to everyone else.

00:04:21.649 --> 00:04:26.450
Now you have 1,620 divided by
9 shares, that should still

00:04:26.450 --> 00:04:32.120
get you to be $180 per share,
if I did my math right.

00:04:32.120 --> 00:04:35.400
So 1,800 minus 180
gets you 1,620.

00:04:35.400 --> 00:04:38.425
It should still be
one $180 per share.

00:04:38.425 --> 00:04:40.300
But this is the nature
of an open-ended fund.

00:04:40.300 --> 00:04:42.690
You can keep creating
shares and selling them

00:04:42.690 --> 00:04:44.380
to the public to
raise more money.

00:04:44.380 --> 00:04:46.650
Or when someone wants
their money back

00:04:46.650 --> 00:04:49.010
you essentially buy the
share back from them,

00:04:49.010 --> 00:04:51.010
give them their money
when you buy it back,

00:04:51.010 --> 00:04:52.310
and you remove that share.

00:04:52.310 --> 00:04:55.470
So an open-ended fund, really at
the close of every trading day,

00:04:55.470 --> 00:04:57.220
can keep growing or shrinking.

00:04:57.220 --> 00:04:59.590
It could be keep adding
more and more investors.

00:04:59.590 --> 00:05:01.720
Or their investors can
take their money back.

00:05:01.720 --> 00:05:04.970
What's difficult about this
from the fund manager's point

00:05:04.970 --> 00:05:06.920
of view, is that they
have to manage this.

00:05:06.920 --> 00:05:08.910
They have to manage
this constant buying

00:05:08.910 --> 00:05:10.384
and selling with the public.

00:05:10.384 --> 00:05:11.800
They have to manage
the paperwork.

00:05:11.800 --> 00:05:13.341
And if you think
about it, they can't

00:05:13.341 --> 00:05:17.937
have all of their money invested
in relatively illiquid assets,

00:05:17.937 --> 00:05:19.020
or even in regular stocks.

00:05:19.020 --> 00:05:20.960
They have to keep some
amount of their money.

00:05:20.960 --> 00:05:23.040
And it's usually like 3% to 5%.

00:05:23.040 --> 00:05:26.550
They have to keep some of this
$2,000 before he lost my money,

00:05:26.550 --> 00:05:28.749
they have to keep
some of it in cash.

00:05:28.749 --> 00:05:30.290
And from an investor's
point of view,

00:05:30.290 --> 00:05:32.330
they would say, well,
if I'm good at investing

00:05:32.330 --> 00:05:34.670
I should try to minimize the
amount of cash that I have

00:05:34.670 --> 00:05:36.294
because I'm not
getting return on cash.

00:05:36.294 --> 00:05:38.400
But because it's open-ended,
because investors

00:05:38.400 --> 00:05:40.830
might come by and say,
hey, I want my money,

00:05:40.830 --> 00:05:45.080
you have to have a little bit of
cash as part of the asset pool

00:05:45.080 --> 00:05:48.930
in order to be able to
buy people's shares back.


Open-ended mutual fund (part 1)

WEBVTT
Kind: captions
Language: en

00:00:00.790 --> 00:00:02.790
Let's say Pete over
here thinks that he's

00:00:02.790 --> 00:00:04.570
a pretty good investor.

00:00:04.570 --> 00:00:07.110
So what he does is, he has
an idea that says, look,

00:00:07.110 --> 00:00:08.810
I'm going to create
a corporation.

00:00:08.810 --> 00:00:10.393
And I'm going to get
a bunch of people

00:00:10.393 --> 00:00:12.130
to contribute money
to that corporation.

00:00:12.130 --> 00:00:14.180
And then I'll manage that
money, and maybe I'll

00:00:14.180 --> 00:00:17.040
take a little fee for
myself, so that I can maybe

00:00:17.040 --> 00:00:19.230
hire some analysts,
or get some computers,

00:00:19.230 --> 00:00:21.040
or get some office space.

00:00:21.040 --> 00:00:23.490
What he does is he
sets up a corporation.

00:00:23.490 --> 00:00:27.030
Let's say he sets up a
corporation right over here.

00:00:27.030 --> 00:00:30.010
And let's say the way he
first sets up the corporation,

00:00:30.010 --> 00:00:31.540
let's say it just
has four shares.

00:00:31.540 --> 00:00:33.480
And I'm making the
number really small

00:00:33.480 --> 00:00:35.735
just to make the drawing
and the math easy.

00:00:35.735 --> 00:00:36.860
This wouldn't be realistic.

00:00:36.860 --> 00:00:39.660
Normally it would be something
in the hundreds or thousands

00:00:39.660 --> 00:00:41.500
of shares, or maybe
even more than that.

00:00:41.500 --> 00:00:43.110
But let's say it
has four shares.

00:00:43.110 --> 00:00:45.620
And let's say all the four
shares are owned by Pete

00:00:45.620 --> 00:00:49.720
initially, just to
simplify the explanation.

00:00:49.720 --> 00:00:55.859
And he puts in $400
into this corporation.

00:00:55.859 --> 00:00:58.400
So another way to think about
it, in exchange for him putting

00:00:58.400 --> 00:01:01.390
$400 into this corporation,
he gets four shares,

00:01:01.390 --> 00:01:07.720
or each share is
worth $100, each

00:01:07.720 --> 00:01:09.670
of these shares right over here.

00:01:09.670 --> 00:01:12.420
And so what he does is he
registers this corporation--

00:01:12.420 --> 00:01:15.370
and I'm talking about
a US-specific case,

00:01:15.370 --> 00:01:17.410
but there's similar
types of organizations

00:01:17.410 --> 00:01:20.640
in other countries-- he
registers this organization

00:01:20.640 --> 00:01:24.950
right over here with the US
SEC, Securities and Exchange

00:01:24.950 --> 00:01:25.640
Commission.

00:01:25.640 --> 00:01:29.030
And he also registers
himself with the SEC.

00:01:29.030 --> 00:01:31.860
Or even better, he registers
a management company

00:01:31.860 --> 00:01:33.360
that he runs with the SEC.

00:01:33.360 --> 00:01:37.930
So let's call it Pete Inc. It's
a corporation he starts off

00:01:37.930 --> 00:01:40.522
that he also registers
with the SEC.

00:01:40.522 --> 00:01:41.980
And when he registers
with the SEC,

00:01:41.980 --> 00:01:44.710
he tells them that look,
this company right over here,

00:01:44.710 --> 00:01:47.270
we're going to issue more
shares for more people

00:01:47.270 --> 00:01:48.580
to contribute money.

00:01:48.580 --> 00:01:50.900
And I'm going to manage
this money right over here,

00:01:50.900 --> 00:01:53.620
and I'm just going to take a
percentage of the total assets

00:01:53.620 --> 00:01:54.510
under management.

00:01:54.510 --> 00:01:56.240
Sometimes you'll see AUM used.

00:01:56.240 --> 00:01:58.450
That just means assets
under management.

00:01:58.450 --> 00:02:00.560
That will go to
Pete Inc. every year

00:02:00.560 --> 00:02:04.320
for figuring out the best
place to invest this money.

00:02:04.320 --> 00:02:06.830
And it's usually on the
order of about 1%, sometimes

00:02:06.830 --> 00:02:08.800
a little bit less,
sometimes a little bit more.

00:02:08.800 --> 00:02:10.340
So 1% per year.

00:02:10.340 --> 00:02:14.870
So right now, with only
$400 under management,

00:02:14.870 --> 00:02:17.550
it would only be
about $4 per year.

00:02:17.550 --> 00:02:20.070
But since he registered
with the SEC,

00:02:20.070 --> 00:02:22.630
he can call himself
a mutual fund,

00:02:22.630 --> 00:02:25.170
and he can solicit
funds from the public.

00:02:25.170 --> 00:02:29.830
So it is a mutual fund, he has
jumped through all the hoops

00:02:29.830 --> 00:02:31.660
that the SEC sets up for him.

00:02:31.660 --> 00:02:37.140
So he can market himself as
some type of great fund manager.

00:02:37.140 --> 00:02:38.640
We don't know if
that's true or not.

00:02:38.640 --> 00:02:41.015
And he can also solicit
funds from the public.

00:02:44.690 --> 00:02:46.480
And we're going to
see in future videos,

00:02:46.480 --> 00:02:49.580
there other funds, especially
hedge funds, that one,

00:02:49.580 --> 00:02:51.444
they can't market, and
they can't take funds

00:02:51.444 --> 00:02:52.110
from the public.

00:02:52.110 --> 00:02:54.010
Those can only take
funds from certain types

00:02:54.010 --> 00:02:56.512
of sophisticated investors.

00:02:56.512 --> 00:02:58.220
And what happens in
Pete's fund, and this

00:02:58.220 --> 00:03:00.687
is going to be an open
ended mutual fund that we're

00:03:00.687 --> 00:03:02.770
showing here, and most
mutual funds are like that.

00:03:02.770 --> 00:03:06.030
Let's say that Sal comes along,
he likes Pete's marketing

00:03:06.030 --> 00:03:08.290
materials, and he
says hey, I want

00:03:08.290 --> 00:03:10.110
Pete to manage my money too.

00:03:10.110 --> 00:03:13.720
So Sal goes and he
gives $100, and says,

00:03:13.720 --> 00:03:14.770
Pete, give me a share.

00:03:14.770 --> 00:03:17.620
So Pete creates another
share right over here,

00:03:17.620 --> 00:03:20.170
he creates another share
he gives it to Sal.

00:03:20.170 --> 00:03:23.200
So he gets one share, that's me.

00:03:23.200 --> 00:03:24.480
I get one share.

00:03:24.480 --> 00:03:26.850
And in exchange, I
gave $100 to the fund.

00:03:26.850 --> 00:03:30.990
So now the fund has $500.

00:03:30.990 --> 00:03:33.590
So this is another
$100 right over here.

00:03:33.590 --> 00:03:35.350
And now Pete's
annual fee is going

00:03:35.350 --> 00:03:38.530
to be 1% of this whole
thing, or $5 a year.

00:03:38.530 --> 00:03:40.550
And if this whole
thing grows, let's say

00:03:40.550 --> 00:03:43.960
this whole thing
doubles from $500,

00:03:43.960 --> 00:03:46.660
let's say it doubles to
$1,000, then that $1,000

00:03:46.660 --> 00:03:50.460
is essentially split amongst
these five shares now.

00:03:50.460 --> 00:03:52.190
So all of the people
will essentially

00:03:52.190 --> 00:03:55.860
have their money doubled, minus
whatever Pete's expenses are.

00:03:55.860 --> 00:03:58.110
In the next few videos, I'll
go over a little bit more

00:03:58.110 --> 00:04:01.670
of the mechanics of an
open ended mutual fund.