Investing and hedge funds

The last 24 hours have been a whirlwind so to speak. Not so much because of the gusty winds, which thankfully have subsided, but due to one of my investments: a hedge fund run by an ex-coworker and good friend of mine. The Sellers Fund is named after the manager, Mark Sellers. Today he had their second annual meeting in downtown Chicago. Yesterday though, events were held geared towards out of town investors.

First we took a tour of the CBOE. It was fun to see and then we took a short class before going down to the pits to "trade" puts and calls on a fictitious stock. It was really pretty cool. There was a trader handling the public "book of orders" and then other traders helping us out. It's a simulated session that they've run before, so they know where the stock is moving (it had some wild fluctuations over 30 minutes or so). We started with a position in both puts and calls and were supposed to end the day closed out. We could just close out our positions right away, or add other positions and close them all out later. The traders were having fun helping us (mostly helping the more attractive women in the group....hmmmmm) and then would get on each other about crazy-ass bids they were making and such. It really was neat to see, but also pretty confusing at times.

We headed back to the hotel which was the main base for a change of clothes before heading off to the Sox/Astros game. I knew people who were going to be tailgating, so instead of taking the bus with the other investors (a ride that took about an hour), I hopped on the Red Line at Lake Street and got to 35th street in 9 minutes flat. Nice. That allowed me about an hour of drinking and eating before heading into the game where the other investors were sitting.

This morning was the annual meeting starting with breakfast at 7:30. The meeting actually started at 8:30. Our fund is invested in about 5 stocks right now, that's right FIVE, with about 50% of the $100 million in assets invested in one stock: Contango Oil and Gas. Is that risky? Why yes, it is. But Mark has a great track record so far being up about 35% annually for the last 5 years. Smartly, he started off with the current year's performance which was up 25% net of fees through June 1. That's outstanding!!!

The stock concentration issue led Mark to talk about mutual funds in general. Most funds, he contends and I agree, do not have an incentive to significantly BEAT their benchmark (usually the S&P 500 or some other such index). They are incented to only slightly outperform their benchmark or really just not UNDER PERFORM. If they take a big risk and it doesn't pay off, people will leave their fund and the management team's pay will drop. If a fund has $500 million in assets and they charge 1.2% in fees each year, they bring in $6 million a year in fees. Why put that at risk if your benchmark is the S&P 500 and all you have to do is buy those stocks and be right on one smaller bet which puts you ahead of the benchmark? Why hold less than 100 or so stocks if you don't have too? There's no incentive. Probably 80% of the fund companies operate this way, but they don't want you to know it.

And for a lot of investors, it's not a terrible way to go. If I've ever worked with you on mutual fund selection, you'll recall some points that I will make are that you don't want to buy load funds (funds that charge you money just for the privilege of buying them), you want funds with low expenses (typically under 1%) and you want funds that have outperformed other funds in their category, not funds that have necessarily outperformed their index. So what I look at is how those funds have done compared to funds trying to achieve the same investment allocation goal. That way you have a better chance of ending up with funds that outperform like funds at a lower cost. Win-win!!