Making Sense of Wall Street By Dave Kansas, The Wall Street Journal, January 14, 2006
http://online.wsj.com/article/SB113720566160746750.html?mod=djemTMB It's never been easier to invest for yourself -- but at the same time, it's never been tougher. It takes only a few bucks to get started in a mutual fund, but the options are constantly multiplying, with thousands of funds pursuing multiple strategies and charging myriad fees. Add to that the rapidly evolving investment landscape: Billions of dollars have poured into the lightly regulated investment world known as "private money," encompassing everything from hedge funds to venture capital. Meantime, investing in overseas stock markets, or in commodities like oil and gold, has become commonplace. For the individual investor, stakes are high. With traditional pension funds going the way of the dinosaur, there's pressure to make smart investment decisions, or risk working well into traditional retirement years. Yet investors can drown in contradictory numbers and words. The lingo -- from "arbitrage" to "yield curve" -- makes it sound as if the people in the know would prefer us not to understand. How to make sense of it all? One of the biggest, and most confusing, developments in the investment world has been a surge of cash into hedge funds. Hundreds of billions of dollars have invested in this lightly regulated world, transforming the way that financial markets function. Hedge Funds If mutual funds are the realm of everyone from Joe Six-pack to Jane Billionaire, hedge funds traditionally have been the purview of the well-to-do crowd. These investing partnerships now number more than 8,000 -- but still usually are written about with a broad brush. They are called "secretive" or "fast-moving." And there the discussion ends. That's not very helpful anymore. The hedge-fund world has grown so vast that simple descriptors no longer work, and it's imperative to understand what they are and how they work, even if you don't have your own money in one. With more than $1 trillion under management, hedge funds have become important players in the financial markets. They're starting to pop up in the portfolios of some unexpected investors. Hedge funds have moved from being a province of the wealthy to include pension funds, university endowments and other large institutions as investors. Also, some funds are, in fact, "funds of funds" -- a term for funds that pool money from investors, both small and large, then funnel that money to a group of hedge funds. This approach has broadened the reach of hedge funds to new classes of smaller investors. So what exactly are hedge funds? Essentially, they are a lot like mutual funds, pools of investors' money that the funds' money managers (or teams of managers) can direct as they see fit. But unlike mutual funds, hedge funds have fewer regulatory restraints. They don't have to disclose their investment strategy, nor do they have to say much about what they are doing. They can shift on a dime -- engaging in short selling one week (in other words, making investments designed to profit if prices fall), then reversing that strategy the following. They can borrow a lot of money to maximize investment bets. In short, hedge funds can do just about anything they want to. Hedge funds also charge large fees. Management fees are usually 2% of assets (mutual funds are generally cheaper) and 20% of profits. Now, 20% of profits sounds like a pretty big figure. It is. But the difference is that hedge funds aren't paid when they lose money (except for that management fee, of course), while mutual-fund companies are always paid their fees by investors, regardless of performance. Venture Capital Rich people and institutions, such as pension funds and university endowments, have different investing options beyond the mutual funds that most of us invest in. Besides hedge funds, there's venture capital. In the late 1990s, venture capital caught fire as funds raced to pour money into Internet companies. Some venture funds, such as CMGI and Internet Capital Group, even began trading as stocks. Though venture capital became part of the common lingo, most people didn't really know what it meant. Venture capital is a lot like its name implies -- though one is tempted to place the letters "ad" before "venture." These funds, like hedge funds, are pools of money gathered up from institutions and wealthy individuals. But rather than focusing on the public markets, venture funds focus on small companies that are new and promising. They take great risks on untested or unproven ideas, in hopes that they will reap great rewards. A number of well-known technology companies received early backing from venture-capital funds, notably Apple Computer and Google. But not every venture investment turns out as those two did. Indeed, a successful venture fund is a bit like a successful major-league hitter. For a venture-capital fund, batting .300 means you're doing pretty well -- in other words, about 70% of even a successful fund's investments might be expected to do poorly or fail altogether. Private Equity Private-equity funds comprise an increasingly influential part of the market. Similar to hedge funds and venture-capital funds, private-equity funds gather pools of money from institutions and rich individuals. Unlike venture funds, private-equity funds usually focus on acquiring mature companies or divisions of large companies. A private-equity fund goes shopping for properties it believes are undervalued or that fallen on hard times. Or it hunts for corporate divisions that no longer fit the core mission of a particularly far-flung company. For instance, in 2002, Diageo, a large liquor conglomerate, found itself trying to figure out what to do with its Burger King unit. Not seeing many obvious connections between burgers and Bacardi, Diageo sold Burger King to a private-equity fund, Texas Pacific Group. Similar to a venture fund, a private-equity fund then seeks to improve the business in order to eventually sell it to another large company. Or it will sell it to the public via an initial public offering of stock. Investment Research The research departments at brokerage firms churn out reams of reports, many claiming that this or that stock is a "buy." What can you as an investor glean from all this research? Finding good investment ideas can be frustrating. These research analysts can help, but often an analyst's insights are so widely reported -- online, in newspapers, on television -- that it's hard to get much of an investing edge from them. To find that edge, it's important to understand how this kind of information flows in the investing world. Here's how it generally works. Frank, a big hedge-fund manager, sees that Hank's Software Co., or HSC, has started to turn its business around. Quarterly numbers are looking better, sales are perking up, new markets are improving. He starts to stealthily buy up some HSC stock. He's being quiet about it, because he has a reputation as a shrewd investor -- once other people know Frank is buying, they'll jump in too, pushing the stock price higher before Frank has bought all the shares he would like to buy. Once Frank has bought his fill, things get interesting. Frank might mention to some pals at a brokerage firm that he thinks HSC looking better. These folks will take a look, perhaps buy a few shares themselves, and then kick the tip upstairs to the research department. There, the software analyst takes another look at HSC's filings. As he studies the numbers, he discovers that HSC has, in fact, turned things around. He issues a research report raising his rating from "hold" to "buy." A journalist sees the analyst's report, does some legwork to check it out, and a few days later publishes a story reporting on a turnaround at HSC. It's important to note that at some key steps along the information trail, additional investors are buying up a bit more HSC and, in so doing, pushing up the stock price. Say Frank bought HSC from $15 to $18 a share. By the time the brokerage-firm guy, and his other investing buddies, start buying, the stock has bumped up to $20. The analyst's report pushes the stock to $23. Thus the newspaper reader is seeing an idea that looked smart at $15, but since then, the price has risen much higher. This isn't meant to discourage, rather to explain how a hot tip may not be so hot by the time you hear about it. Is it fair that Frank figures out a good idea early, or that the brokerage-firm people got in ahead of the general public? Maybe, maybe not -- but nobody broke any rules. -------------------------------------------------------------------------------- Adapted from The Wall Street Journal Complete Money & Investing Guidebook by Dave Kansas. Copyright 2005 by Dow Jones & Co. Published by Three Rivers Press, an imprint of Crown Publishing Group, a division of Random House Inc. Write to Dave Kansas at [EMAIL PROTECTED] __________________________________________________ Do You Yahoo!? Tired of spam? Yahoo! Mail has the best spam protection around http://mail.yahoo.com -- This is ZESTGlobal. Post articles on international affairs to [email protected] If you got this mail as a forward, subscribe to ZESTGlobal by sending a blank mail to [EMAIL PROTECTED] OR, if you have a Yahoo! ID, by visiting http://groups.yahoo.com/group/ZESTGlobal/join/ Yahoo! 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