The era of the traditional hedge fund seems to have passed. A series of big name losses, combined with the unappealingly expensive 2 and 20 fee structure (2% of total asset value and 20% of earned profits) have seen investors move away from hedge funds with many even finding greater returns in index trackers.
Perhaps the most damning factor affecting the industry, however, is the inability of hedge funds to match the high returns for which they are famous. Traditionally, hedge funds have been seen as the foray of the high-risk investor who is willing to put their money at stake for the possibility of unmatched gain. Recent reporting, however, has shown that whilst the risk still remains, the returns do not.
In July this year, the Brevan Howard’s central fund reported losses of 5.2% in the half of 2017. This was preceded earlier in January with Odey European Inc reporting annual losses of a startling 49.5%. With seismic losses such as these affecting the industry, it would not be surprising for one to assume that the golden age of the hedge fund is long gone.
For a long time, an alternative to hedge funds was the HFT (high-frequency trading) house. This fully automated trading process allows trades to be made in milliseconds, taking advantage of market movements at the optimum times to allow for maximum returns. However, the market for HFTs has become saturated, and with many firms employing the same strategies, the returns are dying as the unique selling points of HFTs becomes diluted.
So, what’s next? What awaits for the investor with the high-risk appetite, but who still wishes for their money to be invested rather than traded. What is there to fill the gap left behind by hedge funds? The answer might well be more hedge funds.
AI is the hottest topic in not just finance but technology right now, and its presence in the hedge fund industry could well and truly be a diverse turning point for the sector’s future. The fundamental concept of AI is to utilise machine learning in order to automate decisions that cannot be automated by standard computation alone.
In other words, it involves the unconscious making conscious decisions. It would not be improbable for, in the near future, AI investment and AI fund management to be a tangible concept. If AI can be taught to make informed decisions, then investment decisions should be well within the potential grasps of an AI engine.
This is particularly appealing for followers of the cyclical markets theory. Machine learning relies on the feeding of data in order for the AI to see patterns and make decisions. If AI was given market data from the past, it should therefore be able to make informed investment decisions through comparing current market trends to those that have occurred previously.
Whilst the science of this has been attempted by numerous ‘human’ fund managers with varied successes, the capacity of an AI fund manager to calculate and comprehend huge data sets could see close to “perfect” investment decisions being made.
Indeed, AI could well and truly be seen as not only the future of hedge funds, but also of all investment. Realistically, however, it is only hedge funds- with their higher appetite for risk- who would be placed to be the first on the scene and to utilise the full benefits of AI investment. Unfortunately, should hedge funds be successful in maximising returns through AI, they could also be responsible for their own demise.
In the meantime, however, AI is fast becoming a recognised reality in the financial services sector. The rewards for those first on the scene to utilise it innovatively could be astronomical.
Venezuelan Digital Currency Backed by Oil
Venezuela has announced plans to launch a digital currency, “the petro”, backed by the country’s oil and mineral reserves. The petro aims to help ease the country’s monetary crisis but sceptics claim the proposal has no credibility and will not help those in extreme need.
Why It’s Important
Hyperinflation has eroded the Venezuelan bolivia’s value by 97% this year, making imports incredibly expensive and causing many to abandon trust in the currency. The country’s oil reserves made up 95% of its exports in 2016, while oil and gas extraction accounted for 25% of GDP. Rich supplies of resources provide some initial credibility to the proposal, but President Maduro’s questionable track record when it comes to monetary policy is making many sceptical about the proposal. His currency controls and money printing have only added to the monetary crisis. Maduro has not announced when the digital currency would come into use or any details regarding how the country would create such a system.
Opposition leaders argue the country’s shortages of food and medication are far more pressing and that the digital currency will not address this. The digital currency may provide a more trusted medium of exchange, but it is unlikely to help those in excessive poverty.
Venezuela’s Inflation Is at 4000%. Here’s Why
Venezuela’s currency, the bolivar, has lost 96% of its value this year. As the currency becomes near worthless, imported food and medicine are in short supply. A humanitarian crisis is unfolding.
The government and state-owned oil company, PDVSA, owe bondholders $60bn alone and have recently defaulted on debt repayments. More defaults could mean investors seizing their stake in Venezuela’s oil.
Why Is Venezuela in Debt?
Acting upon the country endowment of natural resources made it an economic success in the mid-2000s.
Yet, while the price of oil skyrocketed during the late-2000s, former President Hugo Chávez matched this with Venezuelan public debt.
Once the price of oil dived in June 2008, lenders stopped extending credit to the country.
Defaults on government bonds are largely to blame for this inflation.
In 2016, OPEC found that oil reserves accounted for 95% of the country’s exports, while the oil and gas extraction combined made up 25% of its GDP.
Venezuela’s overdependence on oil and lack of saving during its heyday are the leading causes of the current crisis.
The Psychology Behind Saving
The idea that the poor do not save enough money just because they are simply “too poor to save” is wrong.
Gambian farmers have in the past saved in cash (wooden lockboxes with savings were smashed open in an emergency or once the savings goal was reached), stored crops, and consumer durables. Saving in livestock and jewellery enabled other farmers to convert cash into less liquid assets to prevent unwarranted and frivolous spending. A detailed household survey conducted in 13 countries found that for many people in the developing world saving may be counter-intuitive. The poor and the extremely poor, those living on less than $2 a day and on less than $1 a day, respectively, do have a significant amount of choice in regards how to spend their money.
The Developing World
The poor do not use all of their income to buy calories, but only allocate between 56% to 78% to food. Spending on tobacco and alcohol (considered non-essential and nonfood items), and festivals (weddings, funerals or religious events) plays a significant role in household budgeting. For example, the poor in rural areas of Mexico spent slightly less than half the budget on food, and 8.1% on alcohol and cigarettes. The poor and the extremely poor spend about the same on food, which suggests that the extremely poor feel no extra compulsion to purchase more calories. Instead, the remaining income is often saved across a variety of informal saving groups, including peer-to-peer banking and peer-to-peer lending.
It is often the poor, women and the rural communities who are the least banked (those without an access to formal banking services). Not surprisingly, without an access to savings accounts or other formal financial services, it is difficult for families to manage unexpected risks, like illnesses, or plan children’s education. But the desire to save and engage with financial services is still there, as shown by a large uptake in the savings plans in Kenya despite high-interest costs, high withdrawal fees, and close to negative interest rates.
Yet, inchoate financial infrastructure in the developing world cannot on its own explain undersaving. Behavioural economists argue that the poor are no different to the rich in their saving habits: both groups are subject to cognitive biases and inherent human irrationalities and face self-control problems. When it comes to saving, “present bias” (or procrastination, proverbially) occurs when people give stronger weight/preference to an earlier option or purchase that provides instant gratification, rather than setting some funds aside for emergency use. Due to income uncertainties, however, the consequences of this “live for today” behaviour are far more detrimental to the poor than on the rich.
The Developed World
Undersaving is not exclusive to the developing world. Household saving rates, the difference between disposable income and consumption, vary greatly across the world. In 2017, Switzerland and Luxembourg, closely followed by Sweden, are the three countries with the highest savings rates. However, a higher GDP per capita does not necessarily equate to a higher savings rate.
In other words, people with higher income in the developed world countries do not always save more. Consider the US with GDP per capita $57,466 and savings rate of 5.3% and the Czech Republic, GDP per capita $35,127 and a savings rate of 6.7%. Similarly, with GDP per capita of over $43,000, the UK’s household savings rate was 3.3% in 2016, the lowest level since 1963, while in Hungary ($27,008 GDP per capita) the savings rate has been on average 4.5% in the past three years.
Is it possible to fully comprehend the monetary hurdles of low-income families? Undoubtedly, consuming today might be a rational choice and a necessity to survive. But, biases deserve context. For many in the developing world saving at home still remains hard. Technological innovation in finance and growth of electronic wallets have already alleviated some of the hurdles of saving money, but technology is not the silver bullet that will address undersaving. An active and conscious commitment to saving and awareness of biases could have a strong beneficial impact on the lives of the poor.
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