Watch out for gift card expiration and fees!

Well the holidays have come and gone. If you were a good boy or girl, chances are you got a gift card from somebody for something for Christmas, Hanukkah, or New Years. Now that the dust has settled, don't forget to use those cards instead of letting their issuers get the better of you by charging you extra fees or worse yet deeming your gift card expired.

Thankfully, the fine folks at Bankrate have you covered when it comes to gift cards. They have a pretty extensive list of gift card providers and the various "catches" associated with them. They also have a great article on the pitfalls of gift cards.

The bottom line with gift cards is pretty simple. If you have a "credit card" style gift card from Am Ex, Discover, MasterCard, or Visa hurry up and use it because it is wasting away as we speak due to the fees they are charging you. Likewise, cards from malls waste away quickly with all the fees they charge. Many retailer gift cards lack fees, but some may expire so be sure to know the fine print.

Happy shopping!

What is a hedge fund?

The conversation usually starts like this.
"Hi. I am so and so, nice to meet you Armchair. So Armchair what do you do for a living?"
"I work at a hedge fund."
Blank stare...
Then the question.
"What's a hedge fund?"

I probably give a different five minute answer every time I have to answer the question, so I figured I would put it down in writing so I can give the same consistent answer every time I get the question from now on.


What is a hedge fund?
A hedge fund is typically a limited partnership that is put together with the goal of generating investment returns. These partnerships are very loosely regulated by the government (in certain instances they must register as investment advisers and file 13Fs). They are typically run by a "general partner" who is either an individual or investment team. The general partner makes all the investment decisions, while the "limited partners" contribute their capital to a common pool and share in the gains or losses incurred by the general partner. The limited partners typically pay a fixed management fee of 1-2% of assets annually, plus an incentive fee equal to 20% of any profits that are generated.

For example if a $100 mil fund is up 20% in a year the fund will take a 2% management fee of $2 million and 20% of the $20 mil in return they generated as an incentive fee- in this case $4 million. The investors will be left with $114 mil or a 14% "net of fees" return. Many funds have a high water mark meaning investors do not pay incentive fees again until the fund recoups any losses it incurs. Management and incentive fees can vary widely among different funds.

Hedge funds are generally limited to 100 limited partners and are only available to accredited investors which are defined as individuals with $300k in annual income or $1 million net worth (excluding the value of the individuals home). Hedge funds are not allowed to advertise publicly like mutual funds which helps contribute to their aura of secrecy and mystique. Typical clients of hedge funds include: wealthy individuals, pension funds, endowments, and other hedge funds (often referred to as "funds of funds"). Hedge funds generally employ or are allowed to employ leverage (i.e. borrow money) to enhance their returns.

Hedge funds are also known for their ability to short sell. When a fund shorts a security, it sells a security that is borrowed from their broker right now. The fund hopes to close the position (referred to as covering the short) by buying that same security back at a lower price and giving it back to their broker. The firm captures the difference between the price they sold it at and the price they buy to cover at as a profit. So if a fund shorts 100 shares of CSCO at $30 and buys CSCO to cover at $25 a week later they book a $500 ($5 x 100 shares) profit. Shorting is considered risky because the potential losses can technically be infinite while the potential gains are finite.

The underlying concept of hedge funds (and the reason people invest in them) is that they are supposed to generate good investment returns with much lower volatility than traditional long-only equity funds because they can "hedge" their bets. They are also typically not supposed to be directly correlated with the individual bond or equity markets.


Strategies
A little like the many ways there are to lose money at a casino (blackjack, poker, roulette, craps, slots, etc.) there are many different strategies that hedge funds employ to generate their returns. I have listed a few of them and a layman's explanation of what they mean below:

1. Long/Short Equity -- These funds typically make long and short equity bets. They may be net long the market, or net short, or anywhere in between.
2. Short Equity -- These funds are only short equities.
3. Market Neutral Equity -- These funds balance long and short positions equally. Returns are generated only by a manager's skill and not by broad market movements.
4. Merger Arbitrage -- These funds typically try to profit from differences in pricing between acquirers and acquirees.
5. Convertible Arbitrage -- These funds typically try to profit from discrepancies between the price of a companies equity and its convertible debt. Usually these funds short the equity and own the convertible debt.
6. Fixed Income Arbitrage-- These strategies try to capture returns by taking advantage of the discrepencies in the pricing of very similar bonds.
7. Global Macro-- These funds basically try to profit from macro analysis. They use foreign currency, equity, bonds, swaps, etc. to express their macro view and try to profit from it.
8. Funds of Funds -- These funds own several different hedge funds. They are meant to diversify risk as any one individual fund or strategy might be quite risky. However, investors pay dearly for the diversification as they are often charged a double incentive fee structure (i.e. they pay incentive fees on the individual funds and the fund of funds).

Famous Funds

Quantum Fund -- Probably the most famous of them all, this was George Soros's global macro hedge fund. He put hedge funds on the map when he "broke the Bank of England."

Tiger -- Run by Julian Robertson and spawned a bunch of other famous funds including Maverick and Lone Pine.

Citadel -- Started by Ken Griffin shortly after his stint as a hedge fund manager in is Harvard dorm-room. The first major multi-strategy hedge fund.

Renaissance -- King of the Quants. Fund founded by James Simons. Known for stellar returns and eye-popping fees (5% management fee, 44% incentive fee).

Centaurus Energy -- Run by former Enron energy trader John Arnold (age 33). Took the other side of the Amaranth trade and landed on the Forbes 400.


Infamous Funds

Long-Term Capital -- Fund blew up in 1998 (lost $4.6 billion) and had so much leverage the Federal Reserve had to negotiate the bail-out with the counterparties.

Amaranth -- Energy fund that had an epic implosion in September 2006. Rumored to be down 65% on their $9 billion fund.

Sowood -- Fund that blew up $1.5 billion in July 2007; Cidatel bought their positions for pennies on the dollar.

Other Reading

New York Magazine has a great if somewhat dramatized series of articles all about hedge funds and the personalities in the business.
Barton Biggs's Hedge Hogging is a great read about hedge funds and the personalities that run them.
Steven Drobny's Inside the House of Money is a good read about some famous hedge fund managers and their strategies.

Life Insurance: It Takes Forever

For those of you considering life insurance, let me warn you that it takes forever and is quite a hassle. I went through the process last year. First you contact your life insurance broker. You send him a bunch of forms, then he gives you some quotes. One you pick which plan you want then he sends you the official forms. This whole process takes 2-3 weeks. Then you have an appointment with a paramed where they will take your blodd pressure and blood and urine samples. You can expect this to take another 2-3 weeks to get setup. The life insurance company may call you and ask you to verify your medical history orally. Finally, they will spend several weeks reviewing your paperwork. All in the process took me almost three months to complete, so be prepared. Despite all the hassle, rates are as low as they have been in years so now may be the time to consider some term life if you have people that depend on your income. For more about life insurance see my prior post on the topic.

Online Glasses Experiment Part 3: Optical4Less Delivers!

Well, they took a couple weeks to get here (as is to be expected when they come from Hong Kong), but my glasses arrived and they work great-- no space alien looking cats! Total cost including shipping: $75. I highly recommend optical4less.com. I now must send my old glasses to the eyeglasspeople.com to have my lenses changed, I will be sure to let you know how it goes. Finally, I am still waiting for 39dollarglasses.com to send me a label to send the glasses that were made wrong back. Their customer service has been abysmal. I would avoid buying anything through them.

Why Are Taxes So Complicated? And a Simple Proposal to Fix Them.

The U.S. Tax System is broken. Any system that requires professional help, the use of a computer to file, and costs a bunch to file is broken in my opinion. The Federal Government estimates is takes 3 billion hours per year to comply with the tax code. The mean hourly wage in the United States is $18.84/hour. That means on average it costs at least $56 billion per year for Americans to file their taxes. We should absolutely scrap the entire U.S. Tax Code as it exists today.

What should we replace it with? I'd say a national sales tax is one simple solution. 45 of 50 states already collect a sales tax, so the incremental cost of implementing the system shouldn't be too much and we have already proven that collectin sales taxes CAN work. While I can't say I am an expert on it yet, the Fair Tax proposal seems to be a fairly evolved attempt at a flat national sales tax. It is supposedly bipartisan, though it appears to only have the support of two democrats in Congress which is not exactly a ringing endorsement. It gives rebates up to the poverty level, sheltering the poor from taxes altogether. It will dramatically reduce the cost of compliance since we already have a redundant sales tax system in place. Evasion will probably be no worse than under the current income tax system (some likely to happen under both systems).

The Stock Market is Getting Crushed! Should I Sell Stocks in My Brokerage Account or 401K?

Well, we are definitely having a correction. If the U.S. equity markets follow the Europeans they will be down 15% for the year tomorrow or 20% from the peak of the market in October. Many readers may be wondering what they should do with their stocks given the big correction? The answer is it depends on your time horizon.


For those with a long time horizon (10 years or more) and that should be most of you, you should generally ride this out and stick to your plan. Below you can see the inflation adjusted returns for stocks vs. bonds since WWII from this article in the FPA Journal.

As you can see, on an inflation adjusted basis stocks have far outperformed bonds since World War II. I particularly like this table because it only goes through 2003, before the market recovered from the tech bust. The bottom-line here is that as long as you have a long-term time horizon you should do better owning stocks than bonds. That suggests that you should not bail out of all your stocks just because the market takes a dive. Instead you should view it as an opportunity to buy more because good companies are now on sale. Remember to maintain your international exposure as well, these stocks will be the most volatile in market swoons, but they should also have the more growth than US equities over the long term. Emerging markets stocks should be particularly volatile, but should also have the best long-term growth characterization.

If you plan to retire in less than 10 years, you should have at least 30-40% of your portfolio in bonds or cash. If you do not I would advise immediately raising enough cash to survive for your first 5-7 years of retirement and then ride out the rest of your equity exposure with a long-term view.

The bottom-line is: don't panic. Most recessions last 12-24 months or so. Stocks have historically represented a great long-term investment and they should continue to do so in the future. The worst thing you can do is panic and lose confidence in your investment plan. Stick out the tough times and even invest more in stocks that go "on sale" if you can afford to and you will be rewarded over the long-term.

Please note that the above is merely the opinion of the author. Please consult your financial professional about your specific circumstances.

The Cheaper Alternative to Glasses: A Failed Experiment So Far.

Well, my cheap eyeglasses experiment is a dismal failure so far. The pair I ordered from 39dollarglasses.com came quickly enough (within one week), but there was one problem. When I put them on my fluffy litttle black cat looked like a blurry fire-breathing space alien (I'm still having nightmares)! Everything was blurry, even moreso than without wearing the glasses at all. Well, I knew that meant one of three things: 1) I had entered the prescription info wrong, 2) my doctor had written down my prescription wrong, or 3) the glasses were made wrong. It was pretty clearly not number 1. My receipt matched my prescription exactly, so I had entered it correctly. I had to go back to my doctor's office to resolve number 2. Sure enough as soon as he put the glasses in his machine he was like "These are really messed up." All signs pointed to #3. It turns out they made the left eye +1.25 instead of -1.25. Also the right eye power was -2.0 despite me entering -1.5. Needless to say I am feeling like I got what I paid for. I emailed the company about 2 days ago explaining the problem and despite an automated reply that said I would hear from them in 24 hours, I have heard nothing yet. Meanwhile, undeterred I entered my prescription at optical4less.com and we'll see if they can come up with something better. I have not sent my old frames to the eyeglass people yet to be replaced because I want to be sure I have another pair that I can use as a backup first. However, their box for me to mail my glasses to them arrived in a jiffy so at least so far they are living up to their promise to make ordering lens replacements online easy. The saga continues...